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Today – Taxes, incentives, and repatriation of profits. We will start with a look capital structure to the extent that it might limit your ability to take some tax deductions.
This is show 12 of our 13 week season looking at what you need to know to successfully take your business overseas. Next week we will wrap up with a review of the topics we have covered this season. The podcasts provide a high level guide to the topics you need to know about when embarking on your international entrepreneurs journey. Download them – listen on your commute to work.
Thin or thick capitalization – what it is and why countries/tax authorities care.
o Limiting the amount of debt on which interest is tax deductible or limiting the amount of interest tax deduction as a percent of taxable income.
Related topic is BEPS
Domestic tax base erosion and profit shifting (BEPS) due to multinational enterprises exploiting gaps and mismatches between different countries' tax systems affects all countries. Developing countries' higher reliance on corporate income tax means they suffer from BEPS disproportionately.
In 2019 working together in the OECD/G20 Inclusive Framework on BEPS, over 139 countries and jurisdictions are implementing 15 Actions to tackle tax avoidance, improve the coherence of international tax rules and ensure a more transparent tax environment.
OECD has put together materials to help developing countries reduce the impact of BEPS such as:
These rules were not targeted at smaller entrepreneurs, but we are bound by them and have to obey them. Seek professional advice about the rules in your target country, not all countries have thin capitalization rules.
Interest is not the only way of repatriating profits, dividends, management fees, royalties or license fees are other means. Withholding taxes (WHT) on these payments may differ so again understand the rules in your target country. DTAs can limit the level of WHT or eliminate it altogether.
Understand GST and VAT tax systems if applicable, these can be quite different from countries that use a sales tax system
Expat employee taxes. If you use employees from your home country to work in the target country, understand when they will become eligible to pay taxes in the host country, usually 181 to 183 days but some are less. If the home country taxes on worldwide income then the employee may be liable for tax in both the host and home country.
Tax authorities do talk to each other to be aware of this fact. A quote from an Australian government publication: Since September 2018, we receive and exchange financial account information with participating foreign tax authorities. This ensures Australian residents with financial accounts in other countries are complying with Australian tax law. You could receive penalties and interest charges if you do not declare your foreign income.
Incentives to encourage investment are typically offered by governments at the national, regional and local level. Incentives started to become popular after the Second World War as countries began to rebuild. Incentives have expanded with the growth of the global supply chain as governments have competed to attract foreign investors that match the countries economic needs.
There is no single definition of what qualifies as an investment incentive, but I like to think about it along the lines of the definition of a bribe in most anti-corruption legislation – it is anything of value.
Broadly there are three categories of incentives.
Financial incentives which are usually directed to cash flow, typically in the form of a grant that minimizes the investment cash required in the up front investment needed to get the new project up and running. These tend to be preferred by developed countries and often used to encourage setting up in less economically successful parts of the country. Investment grants may come in the form of low or no interest loans, sometimes up to 50% of the total investment value. They obviously give instant help to the investor, but can attract the criticism that they are give taxpayers money to a foreign corporation. At least in the short term.
Fiscal benefits – tax breaks, tax holidays or reduced tax rates. Usually these are for a limited period of 3-5 years. Often favored by developing countries who may not have the funds available to provide up front grants. Tax breaks also carry a lower risk to the provider of incentives. Up front grants can be lost if the new venture is not successful. Tax breaks only provide benefit if the investment is successful. Other fiscal concessions can include accelerated depreciation allowances, duty drawbacks, suspension of tariffs on exports or imports.
Economic zones which have different regulations from the rest of the country, often with tax privileges, such as lower corporate tax rates etc.
Other incentives – a broad category that can include:
As an investor the certainty of the incentive the better it is. The earlier it is in a project and nearer to cash are attractive.
The degree of regulation differs widely across the world. The EU incentive scheme is heavily regulated to reduce competition between member countries, avoiding bidding wars. There are rules to encourage investment in low income countries and low income regions within countries. Brexit has raised concerns that the UK is now free to do what it wants and the level playing field across Europe will become tilted in the UK’s favor.
In contrast the US is lightly regulated and this can create state to state competition. Some parts of the US such as the South Eastern states are quite aggressive in encouraging investment, the North East less so.
Incentive programs often follow economic cycles. Following the global economic crisis governments were extremely aggressive in their incentive programs as they sought to rebuild their economies. Likely we will see something similar as the world emerges from the Covid pandemic, especially in hard hit industries such as hospitality,
Governments use incentives to help them pursue their development strategies. They can bring new opportunities to declining markets, bring new technologies into their country, and boost business environments. Like any negotiation the better you understand the other party's motivation the better the deal that meets each parties mutual benefits can be agreed.
If you want to learn more about the incentives available in your host country check out Deloitte’s Global Survey of investment and innovation incentives.
Repatriation of profits
Having achieved success you want to be able to bring your profits home to invest in your next expansion.
• Payment of dividends is the most common method of sending money home, but it does have conditions
o Details of registered capital must be filed and be in accordance with the company’s articles of association.
o Enterprises can only repatriate profits once a year due to tax and compliance regulations.
o Withholding taxes need to be applied.
o Past losses must be made up before dividends can be paid
o If a WOFE it is mandatory to put 10% of profits in a reserve fund until that fund equals at least 50% of the registered capital of the entreprise.
• The use of intercompany payments is a possible option as it has fewer conditions.
o Head office can charge the Chinese subsidiary for support services or intangible assets.
o Must be legitimate, must be at arms length as the State Administration of foreign exchange will be watching. China is very concerned that companies will use inter-co charges to move money out of the country and these payments will require foreign currency, often dollars which China would prefer remain in China.
o This type of payment can be made more frequently than once a year.
o Can be tax efficient as some fees are tax deductible against Corporate Income Tax which is typically 25%.
• Loans are another way of repatriating money especially if the subsidiary is having cash issues. But this is tightly regulated.
o The receiving company must have been located in China for at least one year
o The loan must be a related party and must not exceed 30% of the equity of the enterprise.
o The loan must follow common commercial practices – a fair rate of interest, maximum tenure of five years etc,
Although these methods can be complicated and time consuming they can be accomplished. Profit repatriation is possible even in the most difficult of countries.
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