When he’s approached by a business planning an entry into another country, Mark Loveday CA, director of international tax advisory Transfer Pricing and Tax Solutions, says the company’s management typically already has a structure in mind.

They may have decided to set up a local company, but they may not strictly need to do so, he says.

“If their New Zealand or Australian company is contracting to sell goods or services to foreign customers, will their company create a taxable presence, typically referred to as a permanent establishment, in that foreign country?” Loveday asks.

“If no permanent establishment exists, they may be able to sell into a foreign country without paying any foreign income tax.”

If they do have a permanent establishment (PE), they must investigate whether they’re better off establishing a company or registering as doing business through a PE or branch operation, he says.

“How will the foreign tax be different under a foreign subsidiary or a foreign branch? In many cases, there is not much difference in the manner in which companies and branches are taxed.”

It’s still vital, however, to plan the details before taking the leap.

What are the key tripping points?

Loveday identifies three key tripping points for businesses operating across borders:

1. Setting up a structure that, unwittingly, will be subject to double tax when profits are repatriated to the ultimate owners.
2. Not giving enough thought to the operating model or transfer pricing policies on actual transactions. There are many cases where too much or too little profit is being left in a foreign subsidiary, exposing the group to tax, penalties, and costly audit activity.
3. Not giving enough thought to whether the company could be a tax resident in more than one country.

Avoid double tax

When setting up a foreign company, it’s essential to consider whether it may be treated as a dual-resident company, Loveday says.

“For example, a New Zealand company establishes an Australian subsidiary,” he says. “It has one Australian professional director and one New Zealand director. There are initially no employees in Australia.

“That company is resident in Australia by virtue of its incorporation. It will invariably be controlled and managed by New Zealand executives and considered a New Zealand tax resident as well. The group can then self-determine that its tax residence will tie-break to the country in which its place of effective management exists.”

In this case, Loveday says, the Australian company tie-breaks its residency to New Zealand and must pay New Zealand tax on its profits. It will only pay Australian tax to the extent that it carries on business in Australia through a PE, which may be unlikely if it has no employees or physical place of business.

The biggest issue to address is potential double tax in the form of foreign tax payable on the subsidiary or PE, and tax for the shareholder when a dividend is paid.

“For example, an Australian company with a New Zealand subsidiary will pay New Zealand tax on subsidiary profit,” he says.

“A fully imputed dividend paid by a New Zealand company is not subject to New Zealand withholding tax or Australian company tax. But the dividend paid by the Australian company may not have any franking credits attached. So, the Australian shareholder will pay full tax on the dividend.”

The effective tax rate on those New Zealand profits could be more than 60%, he says. However, the company could be in growth mode, with no intention of paying dividends in the foreseeable future. So, that double tax issue may not be a problem.

Success is about structure

The issue of double tax can sometimes be mitigated through the choice of legal entity. In Australia, limited partnerships might be used to alleviate double tax.

New Zealand companies might establish a sister company, managed and controlled by New Zealand executives, with a registered PE in Australia.

“This could meet the requirements to elect to be treated as a look-through company for New Zealand tax purposes,” Loveday says. “That entity is disregarded for New Zealand tax and therefore the owners are taxed on the company profits and get a credit for Australian tax.

“We are involved in many projects where we are analysing a structure that will mitigate profits that can legitimately be left in a foreign country, without falling foul of the transfer pricing rules.

“This could mean helping clients to determine transfer pricing policies around transactions, such as intra-group transfer of goods, charging for management services from head office, royalties for use on intangibles, or interest on inter-company loans.”

Also, a country might offer choices in relation to the type of entity that best suits a company. For example, in the US, a business could establish a C Corp or a limited liability company (LLC).

Both are established slightly differently. A C Corp is taxed in the US as a company, whereas an LLC is taxed as a partnership unless elected to be taxed as a company.

“That can have major tax implications, depending on how that foreign company is viewed for tax purposes in Australia or New Zealand,” Loveday says.

Other international tax issues to consider

Loveday says there are several other tax-related issues that should be discussed before expanding overseas.

They include:

●      Customs duty on goods being imported

●      Sales tax

●      State taxes

●      VAT/GST obligations

●      Employee tax obligations and social security requirements.

What about recent updates to the OECD Inclusive Framework?

Under Pillar One of the OECD Inclusive Framework changes, there will likely be reallocation of some residual profits of some of the world’s largest companies to countries where customers reside.

“New Zealand and Australia will likely be beneficiaries, as companies like Google and Facebook are likely to pay more local income taxes,” Loveday says. “This is not finalised, though.”

Under Pillar Two, New Zealand has enacted the OECD Global Anti-Base Erosion (GloBE) rules. Income Inclusion Rule (IIR) and Under Taxed Profits Rule (UTPR) will apply to both New Zealand-headquartered groups and inbound groups for the income years beginning on or after 1 January 2025.

“They basically ensure companies pay at least 15% minimum tax on mobile income in countries where they operate,” Loveday says.

“For New Zealand headquartered companies, the requirement is to have revenue over €750 million. There are only about 20 to 25 New Zealand companies that fall into that threshold.”