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What is offshore taxation and its impact on business globally?

As businesses from Perth expand internationally looking for growth the difficult issue of offshore taxation becomes relevant. In effect as you generate profits from another country – that country will seek to tax those profits in that other country. And understanding offshore taxation requires clarity on the tax regimes in both countries.

Introduction to offshore taxation

The difficult area of law is how Australia’s tax regime interacts with the other countries taxation of the offshore business. And as a very high-level overview: the offshore taxes paid in the other country will reduce the Australian tax burden. So business in Western Australia and across the nation will not pay tax twice on their offshore business profits.

This complexity however is increased depending on the type of taxes paid in the other country.  Typically high-taxed countries like the United Kingdom or the United States that charge a dividend withholding tax will give a dollar for dollar reduction in the Australian taxation liability. 

For example – a Perth business owns a subsidiary in the United States. That company is intending to send the Australian head office a $1m dividend before the $150k US dividend withholding tax is paid. The Australian head office would normally pay 25% tax on a $1m dividend however the $150k tax paid already has reduced the Australian tax cost to $100k.

However, for Australian businesses that operate in a corporate structure the Australian head office will not enjoy a franking credit for the US tax paid. So the ability of the Australian head office to pay a franked dividend is limited to only $100k of franking credits compared to a possible credit of $250k is no US tax was paid.

Further, if the UK or US applied a sales tax, income tax (underlying tax) or other type of tax on the profits before they are paid as profits that tax might not give a reduction in the Australian tax liability. 

What is the impact of offshore tax havens?

Much talk is in the media of offshore tax havens. And the best tax effective outcome for somebody wanting to operate an offshore tax haven is if they participate in tax fraud – effectively they require that the income generated offshore is not disclosed to the Australian Taxation Office and the Australian taxation of that income is avoided.

This is the typical (but not only) type of conduct identified in the Panama Papers. And it is understandably fraught with risk and not done by this practice.

If you do generate a “dodgy” form of income in an offshore tax, and you follow the law properly, the ATO will simply treat that income generated as having been generated in Australia (and taxed at Australian tax rates).

How does an offshore tax haven work?

However, an offshore tax haven can work in legitimate circumstances. Business operators can legitimately operate a business in a tax haven, they can have a family member living in that country or they can have invested legitimate offshore business profits that have not yet been returned to Australia.

If you have a business in an offshore tax haven the offshore business is allowed to charge the Australian operations a fee for the market value of the work done. 

An example of this could be if you had software engineers in Ireland or a marketing agency in Singapore (both of which are lower taxed countries). And provided the fees charged by the offshore countries to Australia are at market value the arrangement is fine. The difficulty is in ensuring your documentation of your fees (called “transfer pricing”) is at market value.

Thankfully, Australian middle-sized companies have a Simplified Transfer Pricing Record Keeping Option. This option allows Australian businesses to reduce the massive documentation requirements if they achieve certain business margins and the tax returns prepared correctly show that STPRK was adopted.

If you are structuring your operations overseas you will also need to consider other areas of law like thin capitalization. Thin capitalization is an area of tax law that restricts your ability to charge interest to your foreign operations and reduce your overall tax liability. Likewise, many other countries also have withholding taxes for management fees or insurance premiums.

To this end engaging an Australian tax advisor who is part of an international tax advisory firm (like Geneva Group International) is critical to ensuring that they have the technical competence and understanding of offshore tax regimes.

The tax impact for offshore taxation on business income also applies to the tax on offshore investments. If you generate investment income offshore and you remit it to Australia – you will enjoy a foreign tax credit for the tax on your offshore investments (noting that not all foreign tax paid gives a foreign tax credit).

What is the role of tax havens in the global economy?

Countries will apply different tax incentives to encourage business operators to locate and do business in that country. As an example, Australia has a generous research and development tax offset that pays technology businesses to lose money. Other countries that have a tax incentive include Ireland that applies a lower tax rate to technology businesses.

The generous tax regimes can also apply to the tax on offshore investments as countries seek to attract foreign capital into their country.

So, the world is competing for international businesses and many countries, including Australia, change the tax system to attract those businesses. However, it is also fair to say that some countries, for whatever reason, cannot attract foreign capital and they will offer an artificially low rate to attract persons to live in those countries.

This is often the reason why tennis stars or movie stars live in Monaco – they leave their country to live in a place where the family wealth is lightly taxed (plus it is a nice place).

Internationally countries, including Australia, have introduced a tax concept called “Base Erosion and Profit Shifting” which is effectively trying to tax international companies at a fair and equitable rate.

What are the tax benefits of an offshore tax haven?

As tax advisors we have seen new clients come to our practice with offshore tax havens set up by other people.  In effect the structure is:

            A friendly stranger opens a company.

            The company charges enlarged profits to the Australian operations.

            The friendly stranger pretends that they are independent to you.

Sadly in every instance we have seen this they have become unstuck – either the ATO has uncovered the structure or, most likely, the client has become uncomfortable with the structure.

However if you have family that is naturally resident in another country you might be able to help that person (at a normal family level) or you can alternatively operate your business in a different country or even choose to invest in an offshore tax haven (like buying real estate).  Simply because you have investments in another country does not make them “bad”.

Australia as an offshore tax haven

When talking about international tax planning it is important to remember the impact that death taxes can have on a families wealth. And Australia does not have a death tax.

Further, if you take a strategic tax position with superannuation funds (which are lightly taxed) you might find that you can legitimately create your own “offshore tax haven” within Australia – legal.

Tax is not the only consideration

When looking at offshore structures it is also important to go beyond tax.  Many countries have draconian rules regarding reporting, statutory audits, labour laws and superannuation systems that are not necessary transparent when you first look at that country.

So a deeper view, with on the ground knowledge, is important so your new offshore venture is successful.

Conclusion

The taxation of Australian companies seeking to expand offshore can be complex. And this complexity is increased when some tax jurisdictions have flexible tax systems that are policy driven rather than following the strict process and rule of law.

Most tax structuring for offshore companies is focused on preserving (increasing) the Australian tax payable to increase the total franking credits available to the family members and simplifying the record keeping administration for the offshore company.  As tax advisors we are fortunate to engage with the strength of Geneva Group International – a network of 29,000 tax and business advisors to give you local on the ground knowledge and keep the business administration within the one advisory group.

If you are looking to expand offshore, invest in Australia, or if you are seeking to relocate to (or from) Australia we have the knowledge and connections to give you the tax, structuring and business advice to ensure that your new venture goes as planned – talk to us about how we can help.

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