(Practical Solutions to difficult Problems) Tax Incentives Repatriation - Jeremy Gray

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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.

• Companies are financed by a mixture of equity and debt.
  
• Equity is investment by shareholders and retained earnings. Investors are rewarded by dividends or increase in share price.
  
• Debt is money lent to the company by third parties. Lenders are rewarded by interest payments.
  
• Companies are said to have thin or thick capitalization depending on the ratio of funding between debt and equity. Thin capitalization is when the ratio of debt to equity is high. That is the company is predominantly funded by debt. Thick capitalization is the opposite, the company is primarily funded by shareholder investment.
  
• Why do authorities care? Interest is usually tax deductible. The higher the debt load the lower taxable profits. As the lender could be the parent company this is a means to reduce taxes in the foreign company and to repatriate profits to the home country. If the home country does not tax interest income or taxes it at a low rate – the advantages are obvious.
  
• Countries control this by
  

o Applying withholding taxes on interest paid to overseas lenders.
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:

• E Learning and Training seminars
  
• Tax audit capacity building
  
• Tool kits for low capacity countries
  
• Direct support on BEPS implementation
  

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.

• The use of home based staff in the host country may trigger a permanent entity.
  

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
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: 

• Subsidized infrastructure to increase accessibility and usefulness of a site. Building roads or adding a rail connection. Improving the utilities etc. 
  
• Regulatory concessions, such as speeding up approval processes, help on visa programs for employing foreign workers, family resettlement. 
  
• Employment subsidies covering some of the employee costs of the investor.  Provision of workforce training, such as courses at local colleges or vocational schools.
  
• Like many things incentives can be negotiated, although there are often apparently hard and fast rules on what meets the requirements for incentives, I have found there is a degree of flexibility even with government officials. 
  
• Incentive discussions should be conducted in good faith, you are entering into a long term relationship with local government and community. 
  
• Understand the government’s objectives, is it employment creation? Improved capital investment? Upskilling the workforce.
  
• Generally incentives have moved from employment creation towards capital investment and new technology. However this varies depending on the countries demographics
  

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.

https://www2.deloitte.com/us/en/pages/tax/articles/global-survey-of-investment-and-innovation-incentives.html

Repatriation of profits
Having achieved success you want to be able to bring your profits home to invest in your next expansion.

• I have not yet worked in a country where repatriation of profits is not allowed. A Google search was not able to identify any country that did allow repatriation of profits.
  
• The level of complexity in sending money home varies widely but most countries want to be sure you have paid the relevant taxes and that you are repatriating profits not capital. 
  
• Many countries have rules regarding the payment of dividends. In Singapore dividends can only be paid out of profits. No profits, no dividend. Past year profits can be used to pay profits but the company should not be in a net loss position.
  

China is often considered one of the more difficult countries for repatriation of profits so let’s use China’s rules as our worst case guide.

•    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.


You can contact me via the following links:
mailto:jeremy@business-in-asia.org
Or schedule time via Calendly:
https://calendly.com/3-continents-consulting
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https://business-in-asia.org/
https://thedentistscfo.com/
My LinkedIn URL
https://www.linkedin.com/in/jeremy-gray1

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