You’ve demonstrated the potential of your business. You’ve got the funding you need. And now, you’re thinking about expanding overseas. So, what’s next?
The best time to make key decisions typically comes around very quickly – especially in areas like tax – and that’s why we’ve been sharing our essential tax planning tips for expanding overseas with the Tech Nation Upscale cohort and the Startup CFO network. Hot off the back of those webinars, Steve Leith, our Head of Tech & High Growth, and James Peck, our Tax Partner, have collated their advice below. To read their tips in 5-minutes, simply scroll down. Or, if you’d like to watch a more detailed 18-minute video, head to the bottom of the page.
Either way, enjoy.
6 TAX TIPS FOR EXPANDING OVERSEAS
1) TRADING WITH VS. TRADING IN
First up, you need to establish whether you’re trading with, or trading in a country.
James said: “Don’t assume that if you’re dealing with someone overseas you immediately need to set up overseas entities, because it’s absolutely not a requirement. ‘Trading with’ doesn’t mean you’re creating a presence – but ‘trading in’ is likely to mean you need to consider your local corporate structure.”
2) WHEN DO YOU CREATE A PRESENCE OVERSEAS?
You can create a ‘permanent establishment’ in two ways:
BY HAVING A FIXED PLACE OF BUSINESS
James said: “A fixed place of business in a country generally means a fixed place through which the business of the company is wholly or partly carried on which can include warehouses, office spaces or other locations. That office space doesn’t need to be somewhere you’ve taken a lease out on; we’re aware of WeWork style offices falling within that definition. But also, home offices can be classed as a fixed place of business.
“So, if you have individuals working from a home office that you’ve provided with services and equipment, you could be creating a permanent establishment in that country.”
BY HAVING AN AGENCY PE
If you have individuals who are habitually engaged in the negotiation and conclusion of contracts who are able to sign on behalf of your company, i.e. sales people overseas, you can create a permanent establishment in the country they’re operating in. The key factors are the activities carried on and the relevant authority.
THERE IS, HOWEVER, SOME WRIGGLE ROOM
It should be considered on a case-by-case basis but generally, roles that are preparatory or auxiliary in character might not fall within the definition of creating a permanent establishment. So, it’s always worth considering whether the overseas roles being undertaken fall within this definition.
If you’re just doing some early stage market research into a country, you technically don’t have a presence. You may wish to consider how your business structure the negotiation and conclusion of contracts such that you do not inadvertently create an agency permanent establishment.
James shared an example of a Chief Revenue Officer who was working three days a week in the UK, and two in Ireland. Here, you can separate the types of tasks that the individual does depending on where they’re located. Key activities concerning the UK business are only undertaken in the UK whilst wider administrative and roles pertaining to Ireland would be undertaken whilst in Ireland. Those terms are drafted firmly into the person’s contract, and it means the business can avoid unwanted tax consequences arising in Ireland.
In this scenario, James recommends reviewing the contract every 6-8 months and documenting what the individual does in each location. This way, you have more than the contract as proof if you’re facing a scrutinous diligence process.
3) RESIDENCY RISK
“Something that’s picked up during most due diligence processes is when an overseas entity is centrally managed and controlled by the same individuals as the UK entity, who are also based in the UK, i.e. there is no separation of boards for UK and overseas entities,” James told us.
“In that case, you have an overseas entity that is incorporated overseas, but is centrally managed and controlled in the UK. That could create a potential dual resident entity. HMRC will be saying, ‘we think we have taxing rights over this entity’, and the IRS will say, ‘actually, we think we’ve got taxing rights over this entity’.
“It’s advisable you don’t get yourself into that kind of dog fight between the two over who has taxing rights because it can take years to work out. Both tax authorities are impossible to get in a room together and you quite often end up paying tax in two jurisdictions, which is a nightmare from a cash management position.”
SO, HOW CAN YOU AVOID THAT?
Have separate and distinct boards and board meetings;
Have the makeup of the board include individuals from the overseas entity and not just in a shadow role;
Where possible, the board meetings should be undertaken in said country, with the notes kept and filed there too; and
You should have clear, distinct points around the overseas subsidiary. What is its role? What are the revenue targets? What is it trying to do? How will it grow?
4) HOW TO HANDLE PERMANENT ESTABLISHMENT & SET UP SHOP
If you’ve created a presence overseas, you need to determine whether that entity is a branch or a subsidiary. Then, you need to consider how to register with the relevant tax authorities in that country to make them aware you have a presence.
You then need to determine how to price the overseas operation depending on what the entity’s role is and what is being undertaken in the overseas operation. Consideration might also be required in terms of how the overseas operation is financed, how it utilises the wider group’s IP, what other management services are provided from other group companies – these all need to be considered when calculating an appropriate pricing mechanism.
The pricing decision will then determine how the accounts should be drawn up for the overseas entity and that should feed into the respective tax filings with the local tax authorities.
5) OFFSHORE DEVELOPMENT CENTRES
James said: “If you have a tech centre overseas that’s developing your proprietary technology on behalf of your UK company, it’s probably more appropriate to have some sort of cost-plus entity because you’re not generating sales directly through the tech centre. You therefore need to think about the pricing mechanism and whether cost-plus would be an appropriate measure for the overseas entity.
“If you have a permanent establishment overseas, with a team of individuals working on the technology, the most important thing you need is some form of documentation between the overseas entity and the UK entity that confirms with absolute exclusivity that the legal and beneficial ownership of the IP resides in the UK (if that is the intention), and the overseas entity is developing it on behalf of the UK entity.
Wider consideration should be given in terms of the interaction of the overseas costs and whether these can be included within the UK entity’s R&D claim. You may also wish to explore whether there is an election available to potentially increase the R&D claim based on connected party treatment.
6) THE END GAME: REPATRIATING PROFITS BACK TO THE UK
Generally speaking, this is either going to be through dividends once you’re in a profitable position, through the payment of interest on any loans, management charges, or finally, royalties attached to the IPs generated.
“Your approach should be proportionate and flexed accordingly,” James shared. “One of the areas that needs to be looked at on a country-by-country basis, specifically as a result of the post-Brexit world, is how those need to be considered given the impact of withholding taxes, and how that might mean you don’t end up with a full cash payment as a result. Consideration is also required in terms of whether a reduced rate of withholding tax could be applicable and how this might be achieved.
“The absolute latest you want to think about modelling for any withholding tax is before you make a payment.”
