Many organisations extend their business overseas into new markets, either to diversify their customer base, increase revenue potential or gain competitive advantage. But what are the tax implications?
If your business is considering growth into new territories, there are a number of direct tax issues you should consider carefully and plan for. Although tax rules and regulations vary locally by country, here are the general principles that remain the same.
Will you trigger a tax presence?
This is a key question. It is possible to undertake some business in a country without creating a tax presence or permanent establishment (PE). And if this is the case you may not need to register for corporate income tax.
First, you must determine if a PE exists under the domestic law of the relevant jurisdiction. If it does, the provisions of any Double Tax Agreement (“DTA”) between that jurisdiction and the UK need to be considered, as this may provide otherwise and overrides the domestic legislation. The default tests for a PE are
is there a fixed place of business, for example a place of management, office, factory? and/or
can an agent habitually exercise authority to do business on behalf of the business i.e. to negotiate or conclude contracts?
HMRC takes the view that a company which makes sales through a website does not have a PE in the UK, even if the server on which the website is hosted is located in the UK. Other countries may have different approaches.
If a PE is created, you’ll have to determine how to best structure your business operations in that territory. There are a number of issues to consider including taxation, costs, limited liability, ease of exit and local regulatory and reporting requirements. The two structure options are a local branch or a subsidiary.
Branch or subsidiary?
If you form a branch, the profits or losses made in the foreign entity form part of the taxable profits of the UK company. Where losses are made, the UK company can utilise the losses made in reaching its chargeable profits.
Conversely, where a branch is profit-making, the profits form part of the total chargeable profits of the UK business when calculating the amount of tax payable. In this scenario, the UK business can elect for the profits of a foreign PE to be exempted from UK corporation tax. However, there are restrictions on availability of this relief should you have benefitted from using losses previously.
A subsidiary is however treated as a distinct legal entity, separate from the UK company. It therefore pays tax on its own profits independently of the parent company. If the tax rate in the overseas jurisdiction is lower than the UK, this may be a preferable route.
Since a branch is an extension of the existing company, its funding is more straightforward, with no requirements to decide how to provide capital for use in the business.
For a subsidiary it is more complicated, and can be either through debt or equity. You may need a certain level of equity to comply with local requirements. But remember that equity is tied up and is usually only repaid when the subsidiary is sold. A loan is easier to repay, but may result in withholding tax considerations where interest is paid.
The important of subsidiary location
When a payment is made cross-border, the entity making that payment may need to apply withholding taxes. This can be in respect of payments of interest, dividends, royalties and certain types of services – depending on the territory involved.
The terms of any double taxation agreement between the payer and the recipient may mean withholding tax can be reduced or even eliminated. When withholding tax is applied, it impacts on cash flow where tax relief is possible, or absolute leakage in other scenarios.
What’s more, all connected party transactions must be compliant with local transfer pricing obligations. This may require inter-company agreements and bench marking to establish the arm’s length rate and support the commercial position.
Of course there are many other tax considerations. These include payroll and indirect taxes such as VAT, which should not be overlooked. And local statutory reporting deadlines, and legal requirements as to how a company is formed and operated will be different from those in the UK.
As the requirements vary by jurisdiction, you should always seek specialist local advice. The PKF International Network has representation in over 150 Countries around the world, so if you are considering expanding your business overseas, it is very likely that we can connect you with someone who can help.