Navigating the complexities of the tax world is one of the more challenging aspects of the business world especially in the tech industry – and that’s just operating in Australia.
When it is time to expand into the global marketplace, those considerations get even harder.
Some of the key questions that should be addressed and considered when expanding offshore are:
· What are my long term commercial goals/objectives?
· What legal structure should I use?
· What operating model should I use?
· Where should IP be held?
When expanding overseas and considering the tax implications, it is important to have regard to the commercial considerations of your business:
· Where is my main customer base and do they need to contract with a local entity?
· Where will the development work be conducted and why?
· What are my medium/long term plans for the business? Am I looking to a liquidity event with a discounted capital gain, or am I looking for dividend yield?
· What is my capital management policy? Will profits be retained by the company or paid out to shareholders?
Once the overall goals and objectives have been established, then the fun begins.
Understanding your goals and objectives allows tax professionals to consider what aspects of the tax system are beneficial to you. It is also important to optimise your business structure, especially in the event of a sale or IPO event.
A key aspect of these questions is the relevance of franking credits. Do I need them, or will potential future investors need them?
The optimal legal structure should be chosen to address specific long-term plans.
Tax jurisdictions have generally set up their tax framework to provide relief from double taxation – either by exempting the dividend already subject to tax in another country or by providing a credit for the tax already paid in the other country.
While the intent of most tax policies is to avoid double taxation, there are many instances where this may not be achieved in practice.
This is exemplified by Australia’s franking regime which means that profits derived and taxed offshore can, in certain cases, be taxed again for an Australian shareholder, without limited double tax relief.
Effective tax rates of 60-65% on foreign-sourced profits can easily arise without proper planning.
Aligned to this issue is the question of which entity types to use.
In the US, there are several different entity types with different tax characteristics and this choice can have a profound impact on the effective tax rate from a particular operating structure.
If an individual shareholder in Australia directly owns shares in a US entity, then they are taxed on the dividend received and a credit is provided for any US withholding tax paid – but not any underlying US company tax.
By contrast, if an Australian company held the US shares, the dividend would generally be exempt from Australian taxation but then the dividend passed on by the Australian company to its individual shareholder would be taxable for that individual shareholder, without relief for the US withholding tax paid or the underlying US company tax.
However, in some structures, the individual shareholder would be entitled to a credit for both the US withholding tax and the underlying US company tax – which would of course fundamentally change the effective tax rate of operating offshore.
Transfer pricing is essentially about ensuring that the allocation of the business profits between the relevant tax jurisdictions occurs on an “arm’s length” basis.
Each country wants to make sure they are receiving their fair share of the tax “pie” – but how that pie is divided can look vastly different depending on the approach taken by the business – and the tax authority for that matter.
Something as simple as your operating model can play a big role in how your tax bill is allocated.
It is important to document your transfer pricing policy, as failure to do so can lead to difficulties and issuing arising in the event of an exit event, such as a sale or IPO.
For the tech sector, given the key asset being exploited is generally one subject to copyright, considerations as to whether a royalty exists will often arise, and if so whether this is subject to withholding tax, and at what rate.
Furthermore, for many tech companies which are yet to generate profits, withholding taxes are an incremental economic cost – because there is no ability to claim them as a tax credit.
The impact of this potential cost also needs to be considered when choosing an operating model.
It is important to ensure that the intended operating structure is given legal effect with underlying intercompany agreements executed accordingly. These will form the starting point of any tax authority review.
Intangible property ownership
Australia’s relatively high corporate tax rate and lack of amortisation for IP has meant that Australia has not traditionally been seen as an ideal IP ownership jurisdiction.
For this reason, a lot of tech Australian companies will intuitively consider establishing a foreign subsidiary in a low-tax jurisdiction to own their IP.
However, the allocation of taxing rights to IP does not simply follow “legal form” ownership – rather, an economic substance over form approach is taken.
Here, there are five main factors relevant to the allocation of profit for IP: Development, Enhancement, Maintenance, Protection and Exploitation (commonly referred to as the DEMPE functions).
The main purpose of this analysis is to ensure the profits follow the substance of transactions rather than pure legal form ownership.
This often makes it challenging for Australian tech companies to substantiate having IP owned in a foreign subsidiary.
Overlaying this is Australia’s poorly-understood Controlled Foreign Company regime, which can effectively bring the profits back to Australia anyway.
Furthermore, moving “pre-commercialisation” IP out of Australia, when all of the DEMPE has occurred in Australia beforehand, is considered high risk by the ATO and would be a focus area in any review or audit.
That aside, there are a number of other factors to consider with IP ownership besides the underlying corporate tax rate, including Research and Development (R&D) tax incentives and grants.
In this respect, Australia currently has quite a favourable R&D tax incentive regime in place.
The May 2021 Budget also introduced the concept of Australia’s first Patent box regime to encourage companies to develop and apply their innovations in Australia by providing a concessional tax rate for the exploitation of qualifying patents.
That said, for many tech companies, their core IP is software code, which is typically only able to benefit from copyright protection – not patent registration. Furthermore, it remains to be seen how the new Government moves forward with this.
RSM Australia is a tax, audit and consulting company that has been assisting Australian companies for 100 years, with a dedicated and combined international tax and transfer pricing team that focuses on the SME market.
Danielle is a Principal in the International Tax and Transfer Pricing team, having gained experience in both corporate and international taxation at RSM. Danielle’s focus has been advising clients with international operations, both inbound and outbound around the world, and liaises with other RSM affiliates to ensure a co-ordinated delivery of the client’s desired outcomes. Danielle is a Chartered Accountant, Chartered Tax Adviser and has a Masters of Taxation Law.
Liam is a Partner/Director at RSM Australia with 20 years of experience, 17 of which was with large accounting and consulting firms in Sydney, London and New York. He is a Chartered Accountant and solicitor, and his experience combines the inherently interlinked areas of Transfer Pricing with International Tax, along with experience in ensuring that intra-group legal documents are appropriately drafted. Liam is familiar with the UK, US, Europe and key APAC jurisdictions.
This article has been published as part of a commercial arrangement with ACS.