Businesses are increasingly born global – and, thanks to the internet, are able to access international customers, supply chains and partners.
The web acts as a springboard for businesses to expand overseas and offer goods, services or software products in different markets.
It has spawned global giants of e-commerce such as Apple, Amazon, Google and eBay. Smaller companies too have used the internet and online marketplaces including App stores to rapidly build international businesses.
The global giants are currently facing intense levels of scrutiny about the way in which they are structured in order to navigate international tax regimes. But any online business, no matter its scale, needs to pay careful attention to corporate structure and properly analyse the motivation for international expansion or risk unforeseen consequences.
Businesses need to ask themselves whether globalisation is important to them because it delivers access to foreign markets? Or is it important in order to take advantage of lower labour costs or to access specialist skills? Are there benefits in moving certain activities in jurisdictions with lower effective tax rates? Or is the international expansion all about access to technology and getting closer to customers or competitors?
Armed with that insight, organisations are far better placed to structure the business for maximum benefit for all parties.
There is a common perception that expanding a business overseas and moving profits to lower tax jurisdictions will lower the effective tax rate of the group and automatically benefit its shareholders. Whilst moving income offshore could potentially reduce a group’s effective tax rate, it may not necessarily benefit shareholders. Whilst any dividend income remitted from a low tax jurisdiction will be exempt from Australian tax for an Australian holding company, this dividend does not give rise to a franking credit. This would mean that Australian shareholders pay higher income tax on dividend distributions without the franking credit.
So while this type of tax planning can benefit those groups that are seeking to reinvest profits and achieve capital growth with a view to a future share sale it is perhaps less suited to Australian companies which want to distribute funds regularly to their shareholders.
Many e-businesses meanwhile seek to locate intellectual property (IP) including their brand, product, patent, copyright or distribution rights in a low tax jurisdiction. The company owning this IP will typically charge overseas entities utilising the intellectual property a royalty for using it. This could reduce profits in companies operating in high tax jurisdictions and potentially allow income to be built up in a low tax jurisdiction.
Whilst this may sound an easy proposition, it’s crucial to consider Australia’s controlled foreign company (CFC) provisions and transfer pricing regulations. Where profits arising overseas are from a CFC, they will be attributed back to Australia and taxed so it’s important to consider whether any exemption is available from the CFC provisions. From a transfer pricing perspective, it’s necessary also to consider the level of substance (key operational people) that are available to support the ownership of an IP held offshore and to consider whether any charges for this IP are appropriate.
Without sufficient substance the ATO or tax authorities in other countries could potentially re-characterise transactions or disallow incoming royalties and, or expenses. This could result in unplanned additional tax and penalties.
The issue has been under the microscope recently following a series of negative press reports of perceived profit shifting by international e-businesses from countries such as Australia to low tax countries such as Luxembourg, Ireland, Singapore or the UK and other tax havens. This in turn has prompted the G20 initiative known as the Base Erosion and Profit Shifting (BEPS) review, which has a key focus on the digital economy and tax avoidance.
Meanwhile other, more prosaic taxation issues also pose a challenge for the international e-business.
Each country has its own individual regulations regarding sales taxes, customs duties and withholding taxes. The level of GST can vary widely and needs to be carefully considered when setting up international operations.
For example, groups investing into Europe will look to set up operations in a low VAT (the European equivalent of GST) jurisdiction. By the same token, some online businesses make the most of being able to ship goods costing less than $1,000 into Australia as these do not attract GST.
Customs duty is a further key consideration as it is an added cost to be borne in mind when structuring international supply chains. And, where a royalty or other charge is levied in an overseas country, there could be withholding taxes to consider - especially where a tax haven is involved.
With regard to the location of employees, care needs to be exercised if Australian employees start spending greater amounts of time on the ground in other countries as it may create an obligation for the employer to deduct PAYG tax in that country. The employee may also be required to file a tax return in the overseas country as well as Australia.
Finally it’s important to understand the business incentives that are available around the world.
For example Australia and a number of other countries have a research and development incentive that could provide cash tax savings. In Australia, a 45 per cent refundable tax offset is available (equivalent to a 150 per cent deduction) for eligible R&D entities with a turnover of less than $20 million per annum. Other countries such as the UK meanwhile have a patent box regime that allow for a 10 per cent tax rate on income arising from patented products/services which again could benefit e-businesses.
Intelligent international tax structuring can build significant value for e-businesses – but there is no one size fits all approach.
E-businesses with global ambitions need to carefully consider what they are attempting to achieve internationally and why, and use that insight to structure international operations in order to deliver value to both the business and shareholders.
Mark Pollock is a partner in BDO’s tax advisory unit, Nick Drizen is a principal specialising in tax and transfer pricing.