Avoid Being Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
This article is part 8 of a 17-part series on global expansion. You can find the full list below this article.
No matter where you expand your company to around the globe, you’ll likely want to hire talent in different geographical locations to help grow your business. But you’ll need to be strategic with how you position each person, the functions they undertake, the titles you give them, and their reporting lines in order to protect your bottom line and ensure you have the most tax efficient and compliant structure. The location of your people is an important part of your tax model, which is essentially the framework under which both internal and external transactions take place in a way that is most tax efficient for your business.
Let’s say you are part of a Dutch company and you decide to hire a Regional Head of Sales located in Thailand to help with your business expansion into Asia. The guy you hire does a phenomenal job and brings in a whopping $1 million in booked revenue for the Dutch headquarters within the first year. Woohoo!
Not so fast. Believe it or not, even though the revenue is invoiced by the Dutch entity, the Thai tax authorities could easily swoop in and tax a large piece of that revenue!
One reason is because the Dutch company has a “permanent establishment” in Thailand, which means that double taxation can occur due to Double Taxation Agreements in which the “source” country (Thailand) where the profits are earned are being recorded in a “residence” country (Netherlands).
And another reason largely has to do with the placement of your key strategists in your business.
The jurisdiction you choose and the key functions performed in this jurisdiction will affect your organizational structure strategy
When tax authorities in respective jurisdictions audit your business, they could have the power to tax profits made on revenue booked elsewhere if they feel that the local hire is performing activities of a significant value for your company (for example, negotiating contracts on behalf of headquarters), even though that person has been hired under a Thailand company or even as an independent contractor.
In other words, tax authorities would assess the value-added nature of the functions performed by this individual as well as your contracting model, organizational structure, and governance framework to determine how much value has been created and how much authority this individual has in your business. The way you structure his role and functions will impact whether or not you could be at risk of being taxed, or in the worst-case scenario, even double taxed!
So how can you mitigate this and make sure that your company doesn’t face this tax scenario?
The answer lies in the functional profile, your organizational structure and governance (as well as getting what we call “transfer pricing” correct). In the case where the Dutch group has a senior regional salesperson in Thailand, the Dutch group can structure the organization and governance so as this individual can only work within a strict framework and guidelines provided by the Global Head of Sales at the Dutch headquarters. The individual is acting like more of a sales agent referring potential customers to the Dutch headquarters to negotiate the material terms of the contract rather than doing so himself.
By structuring the organization in this way from a functional and governance standpoint, any sales facilitated by that salesperson in Thailand, revenue for which is booked by the Dutch headquarters, can more confidently and justifiably be treated as revenue outside of Thailand. In other words, the strategic sales functions are located outside of Thailand which would make it more difficult for the Thai tax authorities to assert any right to tax any profits from the $1 million in sales.
Your governance policies can protect your IP and any residual profits earned related to that IP
This kind of situation applies to more than just sales functions and revenue. Say, for example, there is a tech company headquartered in Austin, Texas, U.S.A. that hires a person in Indonesia to develop the company’s key software for the U.S. company. Tax authorities in Indonesia could become aware of this and claim that the Indonesian resident person is undertaking strategic product development functions which have resulted in the creation of intellectual property within their territory. They could say that any subsequent revenues made from the software should therefore be taxed in Indonesia.
In this case, the U.S. company should have proactively drafted either a third party contractual agreement (or if this person is employed by an Indonesian entity, an intercompany agreement) in which the Indonesian developer is positioned as performing contract Research and Development under instruction from a more senior person based in the United States. With this legal and transactional structure, anything that the Indonesian developer creates would be considered as U.S. intellectual property, because he’s working under the instructions of headquarters. During a tax audit, the U.S. company has a stronger case to defend the intellectual property as being U.S.-owned, and any future income associated with this intellectual property should not be taxable in Indonesia.
Make sure you align your commercial strategy with your tax strategy
You’ll also want to use this strategy when thinking about how you position your people internationally.
Take, for example, a French headquartered company that wants to expand to Asia and Oceania. They have a contractor in Australia who is now going to be the Regional Head of Sales.
In this case, the French company has a few options to consider, and they’ll need to align their commercial strategy to their tax strategy. For example, if he is negotiating sales contracts and signing these contracts on behalf of France or Australia or other countries, the Australian tax authorities could assert the right to tax any profits generated on these sales. The French company should clearly understand the implications of having this person located in Australia and what functions he is performing and the potential tax risk associated. They should review their tax strategy and align this with their commercial and organizational strategy to ensure that their overall sales team and its day-to-day functions are organized in a way that is aligned with their growth strategy. And, ideally in a tax-efficient way that does not create unacceptable tax risks and costs. This could involve locating the regional head of sales to Singapore and realigning the functions of the regional sales roles and the in-market sales roles so that more of the sales and profits could justifiably be booked in Singapore (a lower tax jurisdiction).
It might cost the company more to employ him as an expat and relocate him to Singapore, but it could potentially save the company more tax overall by reducing the tax burden in a higher tax jurisdiction (Australia) by moving these functions and subsequently profits to a lower tax jurisdiction (Singapore). The company could perform an analysis to see which option aligns with their risk profile and what organizational structure, commercial and tax strategies to choose.
Your commercial strategy should always be the driver, but you should always be aware of the differing risks, tax efficiencies and pros/cons associated with alternative operating and contracting models.
What it all comes down to: aligning value creating functions with location, commercial and tax strategies
Each of these operating models that could improve tax efficiency and mitigate tax risk are effective. But keep in mind that the functional profile of each person and entity needs to align with the governance structure and the profit attribution as these are definitely something that the tax authorities will be checking on.
Ultimately, the location of your key value-creating strategic employees will drive the profit allocation within your group. There may be more flexibility regarding the location of more junior employees (their value could be deemed to be based on their cost) versus more senior strategic personnel (where their value could be deemed to be more related to sales – i.e., a materially higher number!). This should be kept in mind when establishing and aligning commercial, organizational, and tax strategies.
We find that many companies structure their organization in a way that they believe to meet local compliance rules. But sometimes they aren’t aware that they’re taking on a huge risk when they overlook international tax and transfer pricing implications. Need help establishing and aligning your commercial strategy and your tax strategy? Get in touch with us by contacting us, here!
With special thanks to Sam Barrett from EY’s APAC Operating Model Effectiveness team for his inputs and insights in putting together this series of articles.
International Business Expansion Series
This article is part 8 of a 17-part series about International Business Expansion. Here’s a list of the full series to give you a well-rounded understanding of what to consider when expanding your business abroad, from strategy to execution to management:
- The #1 Thing that Companies Need for a Successful Expansion Abroad
- The 3 Components of a Market Analysis to Know if Your Product is Viable Abroad
- How to James Bond Your Profit Margin with Location Analysis
- How to WIN in a New Market with These 6 Models of Execution
- Lost in Translation: How Culture Can Impact Your Business Expansion
- Show me the money: How to Fund Your Business Expansion Abroad
- Risky Business: The 2 Key Layers of your Operating Model to Align with Your Growth Strategy
- Avoid Being Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
- Trash Talk: Why You Need to Analyze Your Processes Before Expanding Globally
- 5 Reasons Why You Should Customize Your Technology for Your International Expansion
- Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
- Landlocked: How your Transaction Flows can Impact Your Access to Funds
- 5 Industry-Specific Legal and Regulatory Obligations that can Impact Your Business Expansion Abroad
- “Health Checks”: Your Ticket to Building a Sustainable International Business
- How Much Is Your Business Worth? 4 Drivers that Increase the Value of Your International Business
- Plug and Play: How to Efficiently Scale Your Business When Expanding Abroad
- Beach, or Boardroom? Plan Your Exit Strategy Before You Expand Globally