As companies mature in their local market, they often grow keen to expand their business abroad and take advantage of new opportunities in foreign markets. Whether it is gaining access to new customers in a new market, or obtaining operational advantages by reducing staffing costs, there are obvious reasons to expanding abroad. In the post-pandemic era reshaped by travel restrictions and a new normal for work, what are the key considerations for companies considering an overseas expansion plan?
Operating in multiple jurisdictions is a complex endeavor that comes with new and often unfamiliar compliance requirements. Thus, the decision to expand abroad must factor into account the potential benefits as well as the increase in complexity, and often cost, that comes with it expanding a business overseas.
Choosing a starting point
For every business, the decision to expand abroad must be accompanied by a clearly defined set of benefits offered by such expansion. With the understanding that operating in multiple jurisdictions comes with increased business complexity and costs, the business should consider whether a legal entity or physical presence in the foreign jurisdiction is necessary.
With the technologies available today and the interconnectivity between major economies, it has never been easier to conduct cross-border business without a legal presence in the country.
This is a viable option for many. For example, retailers selling via e-commerce typically have hundreds of cross-border agents eager to help sell their products to consumers through bonded warehouses and managed services. For other companies, HR agencies who hire employees on behalf of the company offer a compelling middle ground between establishing a legal entity and working entirely remotely from the host country. This can also be a good way for businesses to test the water before making substantial investments overseas.
When the benefits of expanding abroad cannot be so easily achieved, establishing a foreign legal entity is the right choice for expansion. These companies should prepare for the additional complexity of operating in a foreign jurisdiction and work with local company secretarial agencies to smooth the process of registering a legal entity.
The risk of Permanent Establishment
It is important to understand the tax implications when companies decided to expand into overseas markets. For instance, many countries adopt a Permanent Establishment (PE) test to determine whether the business activities carried out in the overseas (host) country warrant a tax residency status. What constitutes the creation of a PE is defined in tax treaties as well as local tax laws; however, said rules converge internationally with few local nuances.
Generally speaking, most tax administrations take into account the physical presence of employees and time spent by staff in the host country, alongside specific business activities, to determine whether the overseas company’s activities constitute a PE.
If the overseas business activities are deemed to constitute a PE, it creates a tax liability in the host country. By virtue of a dual tax treaty, the host country can impose local taxes on revenues generated in relation to the PE. Since a PE is not on equal footing with a legal entity, the business has less control over managing its tax burden. Without proper planning, this creates significant accounting, tax, and legal troubles for the business at home and in the host country.
To reduce PE exposure, companies typically need to either limit business activities as to not warrant the creation of a PE or incorporate a separate legal entity in the host country to carry out its activities. A legal entity is subject to the tax laws in the country in which is it domiciled, allowing the business to more carefully manage its tax burden and take advantage of preferential tax treatment available in local tax laws.
Businesses need to carefully examine the PE risk of their activities abroad and related tax implications. Problems often arise when the business’s activities abroad suddenly create a PE without adequate consideration for the accounting, tax, and legal implications.
Understanding the new tax challenges in the digital economy
Once the decision to expand overseas has been made, the business faces additional tax considerations and compliance requirements both at home and abroad.
As of today, 132 countries have joined the OECD Base Erosion and Profit Shifting (BEPT) initiative. The BEPS initiative is aimed at ensuring multinationals pay their fair share of tax wherever they operate. Governments and tax authorities involved in the initiative have signed on to establishes the synchronization of data collection for taxation and strengthen guidelines for transactions involving the transfer pricing of intangibles and contractual arrangements.
For multinationals, this means that governments are looking more closely at transactions involving related companies and how that affects their taxation at home and abroad.
For example, multinationals operating in countries that have signed onto the OECD BEPS are required to maintain transfer pricing documentation and make disclosure of intercompany transactions to tax authorities according to set guidelines.
For growing businesses, understanding and ensuring compliance with local transfer pricing regulations can be a real challenge. They need the support of local tax specialists to help them establish the internal procedures for documentation and implement locally compliant reporting systems without eroding profitability or compromising the efficiency of business operations.
How we can help
Expanding overseas is a major milestone that many businesses strive to achieve. It’s important that business owners, investors, controllers, and executives do so with clear intent and with an understanding of the complexities that come along with operating a multinational business.
At Integra Group, we work with leading fortune 500 companies and small- and medium-sized businesses to facilitate a smooth entry into Asian markets. Our local experts provide the resources and local ‘know-how’ to go further with confidence.
For more information and inquiries, contact us today.