If you or any of your key employees will be moving to the US when expanding your business, they may have unique tax considerations.

With both Australia and the US taxing their residents on their worldwide income, and taxing non-residents on income that is sourced within the respective country, it is important to be aware of double taxation provisions that help ensure an individual isn’t taxed twice on the same income.

Tax Residency

It is important to determine which country an individual is a tax resident of, as this will impact how that individual is taxed in each country.

When an Australian resident moves to the US for work purposes they will typically become a US tax resident if they establish a home in the US and reside there on a “permanent” basis. Factors that will be considered in determining whether residency changes include whether family is brought overseas with them, if they buy or rent a home to live in, and if they disconnect with ties back in Australia. 

Conversely an individual who lives in the US on a short-term basis, staying in temporary accommodation, and leaving their family back home in Australia, is more likely to remain an Australian tax resident.

A US resident who moves to Australia will face a similar situation. However, the US is fairly unique in taxing citizens on their worldwide income, even if they change their country of residency for tax purposes.

Expatriate Taxation Rules

It is important that you familiarise yourself with both the Australian and US tax rules related to expatriates, so that your key employees who travel from one country to the other have the right information to manage expatriate taxation concerns.

Foreign Earned Income Exclusion

When certain conditions are met, individuals from the US may qualify for the foreign income exclusion. This applies for individuals who reside in a foreign country and earn foreign income. As US citizens are typically taxed on their worldwide income, regardless of their tax residency status, this allows eligible individuals to exclude certain income from their US federal income tax return.

Foreign Tax Credit

Both Australian and the US allow provision for foreign tax credits to be claimed in their resident tax return.

This ensures they are not taxed twice for the same income from both the source country and their country of residence.

Tax Equalisation Policies

Tax equalisation policies are policies that aim to neutralize the impact of an individual’s tax liability when they are working on a global assignment. The objective of these policies is to ensure that the tax burden on an individual is similar to what the individual would have faced if they had merely remained living in their home country.

Australian Help Debts

In the event that you move an Australian employee to the US on a permanent basis, they may become a US tax resident. Ordinarily this would mean that they only need to lodge an Australian tax return to declare any Australian sourced income.

However, if the individual has an outstanding HELP, TSL or VSL debt, they will need to declare their worldwide income. While a foreign resident is not liable for Australian taxes on foreign sourced income, they are still liable for HELP debt repayments based on the value of their worldwide income.

Individual Tax Obligations In The US

As the employer you should be prepared to provide guidance to any key employees that you relocate from Australia to the US. This helps ensure that they aren’t caught unaware of their obligations and tax requirements while residing in the US.

Familiarise your employees with US filing requirements, which are not only different, but can be significantly more complex than Australian requirements.

• The US tax return is based on the calendar year and the filing deadline is mid-April.
• In the US, Individual tax brackets vary from 10% to 37%. The US does have a tax withholding system, that is similar to Australia, to help individuals manage their tax obligations.
• Unlike Australia, where each individual must always file their own return, individuals in the US can file as a single person or jointly as a married couple, or separately as a married couple.
• The US requires individuals to lodge a Federal Tax Return. However, depending on the State in which the individual resides, they may need to file a State income tax return as well.
• Non-residents who receive US income are also required to file a tax return. This means that any employee who is only in the US on a temporary basis will need to file a US return as a non-resident.
• Local Income Taxes may also need to be considered.

Employee Benefits

The US has similar benefits and options for employees as Australia does, however there are some key differences that an individual employee should be aware of so that they can make appropriate plans and decisions for their individual care.

Retirement Plans

US employers are not obligated to contribute towards retirement in the way that Australian employers are required to pay the Superannuation Guarantee. Most employers voluntarily provide retirement benefits through a 401(k) plan (similar to Superannuation).

Health Insurance

While the US has a federal health medical system, Medicaid, to provide free or low-cost health coverage, this is typically limited to low income and disadvantaged individuals. Without a universal healthcare system it is important to consider health insurance, which is commonly provided as an employee benefit.

As an Australian business expanding into the US you will need to consider US, Australian and international taxation issues. Depending on how your business is structured it may be required to pay taxes in both the US and in Australia. As a shareholder, you may also face tax obligations in both the US and Australia.

Residency

The first issue to address with International Taxation is the issue of residency. Your residency, and the residency of your company, is the primary factor in determining which tax jurisdiction has taxation rights over your income.

Both Australian and US residents are taxed on their worldwide income, which means it is important to understand the ways in which double taxation is mitigated.

If you set up a US structure to operate in the US, you will face Australian taxation consequences if the owners and/or managers of the business are Australian residents, and for any interactions you have between your US company and your Australian company.

Conversely, if you use your Australian company to operate a business within the US, you will need to consider the US taxation consequences due to the source of that branch income being in the US.

Tax Treaty

The primary way that double taxation issues are mitigated is through the International Tax Treaty between Australia and the US. When it comes to an Australian business operating in the US, some of the key factors that this Tax Treaty covers include:

• Business profits of an Australian enterprise are only taxable in Australia unless the enterprise carries on business in the US through a permanent establishment there. This means if you establish a permanent presence in the US, your business will be taxed under US regulations. A permanent place of business can be a broad term and may include:

1. A physical place of business including offices, factories, branches, workshops, stores, a place of management, or other physical presence for business operations. 
2. A sales representative of your business who has a permanent establishment who conducts business deals for your business.
3. A permanent provision of services in a specified location, even without a physical presence in that location.

• Transfer Pricing Rules mean that if you have a US entity and an Australian entity, any fees paid between these two entities must be paid on an arm’s length basis. This means there must be a business reason for the fees and a market value basis for calculation of these fees.
• Double taxation is mitigated by both countries typically allowing foreign tax credits to be applied against local taxes.
• The treaty also includes provisions for exchange of information and mutual agreement procedures to resolve disputes.
• A non-discrimination clause ensures that nationals of one country are not subject to taxation in the other country that is more burdensome than that imposed on nationals in the same circumstances.

Withholding Taxes

The Tax Treaty also deals with withholding tax requirements for certain types of income. In some cases, these withholding requirements limit the amount of foreign tax that can be paid on the specified income types.

Dividends

If a US corporation pays dividends to an Australian company that owns 10% or more of the voting stock of the corporation, the rate of US tax on the gross amount of the dividend generally cannot exceed 5%. For other dividends, the rate generally cannot exceed 15%.

For any Australian resident shareholders, this means you will pay either 5% or 15% in US taxes on any dividends distributed to you from your US company. This income is then included in your Australian tax return and you claim the tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

Interest

Interest arising in one of the countries and paid to a resident of the other country generally may be taxed in both countries. However, the rate of tax imposed by the source country generally cannot exceed 10% of the gross amount of the interest.

As an Australian resident any interest income you receive from a US source will be taxed in the US at 10%. The US sourced income then needs to be included in your Australian tax return and you can claim the 10% tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

Royalties

Royalties arising in one of the countries and paid to a resident of the other country generally may be taxed in both countries. However, the rate of tax imposed by the source country generally cannot exceed 5% of the gross amount of the royalties.

As an Australian resident any royalties you receive from a US source will be taxed in the US at 5%. The US sourced income then needs to be included in your Australian tax return and you can claim the 5% tax paid as a foreign tax credit to offset the Australian tax assessed on this income.

International Tax Planning Strategies

Due to the potential complexities involved in dealing with taxes from multiple countries, and the rules and regulations of managing income from multiple countries, it is important to seek appropriate tax advice. International tax planning strategies allow you to optimise your global tax position by factoring in your options around the types of structure, business, and interactions that your business has in the US and in Australia.

Setting up your business overseas is one of the most exciting things that many of us will do in our business career.

Not only are we, as business Founders or C Suite executives, moving with the business – but the idea that we are taking our business proposition to a new foreign market is a thrill and a bit daunting in many respects.

Establishing my business in Singapore in March 2004 was a completely foreign experience in so many respects. There were many logistical challenges to deal with including adjusting to a new business environment, a new regulatory regime and building a totally new market for our product and services.

For most of you setting up or moving a business you will be pre-occupied with establishing revenue earning operations.

This means that often tax and other planning is left until you arrive.

This, of course, is way too late.

This article covers some issues to address ahead of time.

Expecting The Unexpected

Make sure you really examine how to manage a number of common risks as you expand into your new markets including:

• The real financial cost of expansion (it will take longer and cost a lot more to break even)

• The cultural divide between domestic and foreign markets (get a copy of the book The Culture Map by Erin Meyer) which is to say that the way people understand communication and make decisions is often a major reason why the business will not succeed in the new location

• Regulatory differentials between domestic and foreign markets (expect the approach of the regulator in your new country to be vastly different from your home country)

• Download a copy of my book ‘Expatland’ from our Expatland website 

Setting Up Business

Planning your overseas expansion generally requires you working with your accountants in both countries for between six and twelve months before you head overseas.

One of the key things to understand is that if a subsidiary or a branch pays tax overseas there is some form of tax credit when profits are remitted to the parent company.

Sometimes the best country to pay tax in is where the majority of shareholders live. 

This is so that shareholders might be able to get a credit for tax paid by the company.

Foreign tax paid at the company level is generally not something that shareholders in another country get a tax credit for.

You need to spend some time thinking about the best form of business structure also. 

In my experience, while the main forms of business entities can vary from country to country, those countries with English common law regimes, generally have similar types of structures.

Many countries have structures that provide limited liability to owners but are treated as ‘flow-through’ vehicles for tax purposes, so only the owners are taxed. A classic example is a US LLC (limited liability company).

Other Tax Issues To Consider

Your focus should be on the key issues to consider on departure such as:

Issue 1: How does the foreign country tax system work?

In a number of countries, the US being a prime example, there can often be three levels of tax. For example, in New York, there is federal tax, state tax and city tax to contend with. In other countries like Hong Kong, foreign income is exempt from tax.

Issue 2: Transfer pricing issues

What transfer-pricing issues will you have to deal with. Having prices above or below market value for transactions between related companies is a major tax risk in the present global environment.

As an example, recently a prospective client in the global travel business told us that they had a ‘back office’ for their IT department in San Francisco. 

They then told us that their previous accountant had told them they did not have to worry about filing a US tax return – because the branch was not charging any expenses back to Australia and they were just covering their direct costs!

Great news, they thought, until we had to tell them that it was totally incorrect.

Upon a review of the facts of the case, it actually turned out that they had a ‘permanent establishment’ in the US. This gave them a US tax filing obligation.

The previous accountant also completely missed that transfer pricing rules demand that a market price be charged by the San Francisco office to the head office for the services being provided to head office.

Our client had no idea about these issues.

This is one of the challenges we regularly face when dealing with clients coming to us from domestic-only focused firms.

Firms that focus only on single country tax systems with little or no expertise in international tax, nonetheless, often seek to advise clients going overseas. 

Rather than admitting ‘they don’t know what they don’t know’ and looking to work with a specialist firm to get some outside help, they try to do it in-house.

Usually, this leads to expensive mistakes.

Issue 3: Using debt or equity to fund the foreign expansion

In using capital to start your foreign business, one of the key issues to consider is how to get money into your foreign business operation and then how to get profits out.

Many people are tempted to take the view that lending money into the foreign business is easier because it can be ‘repaid’ with little or no complexity. 

The general thinking being that money that goes in as a loan can come out as a loan, right? 

Well, it is not always that simple.

Many foreign countries have rules that require the payment of interest on inter-company loans.

Issue 4: How to send profits to the home country

Having considered how to fund your foreign business and make it profitable, the next question to think about is how profits can be remitted to your home country.

There are a number of techniques that can be used to send profits home. These include dividends, interest, or royalty payments. 

Other techniques include management fees and head office recharge. 

One of the issues to consider here, includes the likely imposition of a foreign withholding tax on payments out of the country. 

Planning profit repatriation is a key issue to consider.

Issue 5: Review your intercompany pricing model don’t assume

Many businesses – especially large American businesses adopt a ‘one size fits all’ approach.

Rather than take a country-by-country approach to looking at how to price transactions between group companies, larger businesses just assume they can apply a Group Policy across the board.

That is not acceptable in most advanced tax regimes.

Consider the real-life case study that I dealt with recently.

CabinetMaker Inc (not their real name)

‘We don’t do things that way’ was what the US-based CFO told me when I suggested they get an arm’s-length review of their ‘global transfer pricing model’ by an Australian transfer pricing specialist.

‘CabinetMaker Inc’, was supplying IT products and services from the US to Australia.

They decided that the Australian company would, ‘just like all other overseas subsidiaries’, receive an 8 per cent payment from the US office for the services it provided the US office from Australia.

A couple of months before, the CFO had called me following a referral from a US client.

Given we have a US–Australia tax specialisation, they called us to see if we would prepare their Australian income tax return for their sole Australian company.

The company in Australia had a ‘representative office’ function.

Its purpose was to source leads in the Australian market and then refer those leads to the US office to complete the sales process and the forming of the business relationship.

The US company was being very careful that what it did in Australia did not give it a ‘taxable presence’.

All reasonably standard stuff they thought.

When I asked how they arrived at the 8 per cent, they mentioned that they had a pricing model in Chicago.

They said that the ‘Chicago model’ was used globally to justify how 8 per cent was ‘payment enough’ for sourcing sales in Australia.

I persisted with a few questions, as follows:

So, with three questions, I could see that CabinetMaker Inc. was relying on a home country pricing model developed with no understanding of the Australian market.

A fatal mistake to make when you are a new company expanding abroad.

I attempted to acquaint them with the realities of doing business away from the US.

They were in another country now and they had to adapt to the differences in the market.

Needless to say, when the CFO hit me with the comment, ‘I will take it to the Board of Directors and come back to you’, I heard nothing more from them.

The aftermath to the above is that recently a story broke in the Australian media that the company, a subsidiary of a US tech company, was being audited by the Australian Taxation Office.

The media reports noted that their transfer pricing practices were suspect.

The global giant failed to adapt its pricing model between group companies and did not want to listen to advice.

They did not want to unlearn what they thought they knew.

They persisted in trying to apply an overseas model without adapting to their new surroundings. 

As a result, their business practices were found wanting in Australia and abroad.

The above mistake is reasonably common; that is, companies expanding abroad believe they can bring their own way of doing business with them. 

Nine times out of ten that is incorrect.

When companies expand to a new country, it pays to go back to first principles, get proper advice and assume nothing. 

Adapting to your new surroundings is essential.

We understand that business owners and entrepreneurs require specific advice from experienced professional advisers in multiple jurisdictions and that a migration tax plan has to be prepared for a company – just as it does for an individual.

Examples Of Unintended Arrival

Example 1 

A foreign company establishes a branch in the arrival country.

This occurs when senior directors of a foreign company remain directors of the foreign company and they change their personal tax residence.

As is commonly the case, the directors continue to ‘run the foreign company’ from their new location. They often do this without realising that they have unwittingly brought the foreign company into the purview of their arrival country.

This triggers tax filing and other reporting obligations.

Example 2

Shareholders leave their home country to live abroad, and while they may not be directors of the foreign company, they remain nonetheless individual shareholders.

In this instance, many tax regimes will demand that tax be paid on the earnings of the foreign company as the profit belongs to the shareholders now living in their new country.

This tax exposure would arise by the ‘controlled foreign corporation’ legislation that many countries have.

If one or both of these unintended actions has occurred, then there is a need to value the assets of the company and understand the value of the shares in any foreign company.

Often, the ‘starting cost base’ of the company assets is relevant because that is the basis upon which future capital gains are calculated. 

Most clients miss this step unless properly advised.

Companies that ‘arrive’ on an unintentional basis now have two tax returns to do one in their home country and one in their arrival country!

Planned Arrivals

When we have an opportunity to work with clients ahead of their departure, we can plan how best to ‘move the company’.

Taking your business abroad is an exciting time for most people. Full of challenges and new opportunities, it is often a make-or-break time for a corporate group.

My view is that if you undertake a proper tax planning exercise covering some or all of the above issues before you leave, then the thrill of setting up your business overseas will not be overshadowed by unintended tax and business issues.

This article relates to foreign business founders with an active business, who are moving to the US. There is a risk that foreign earnings may be double taxed when your organisation is taxed as a US entity. This is due to the application of US attribution rules (Controlled Foreign Corporation (CFC) rules) and Passive Foreign Investment Company (PFIC) rules.

To avoid being double taxed and ensure that foreign tax credits can be appropriately applied, it may be advisable to make a check-the-box election. This election essentially means that foreign corporations are choosing to elect their US tax status at the point in time that the US tax system becomes ‘relevant’ to them.

This check-the-box system is a tax regime that doesn’t just impact organisations that are set up in the US. It can also impact Australian businesses and global businesses when the foreign founder of the corporation moves to the US.

When does the US tax system become ‘relevant’ to a foreign corporation:

The US tax system is considered to be ‘relevant’ to a foreign corporation when one of the following applies:

a) the foreign corporation derives US sourced income;

b) the foreign corporation is required to file an income tax return in the US; or

c) the owner of a foreign corporation becomes a US tax resident (ie a US Person).

Why might a check-the-box election be made?

The most basic reason for making the check-the-box election is to ensure that the owner of the corporation in the US is properly credited with the foreign tax payments. A check-the-box election will avoid the attribution of income under CFC rules or the loss of long term capital gains tax rate discounts when shares are transferred in a passive foreign investment company (PFIC).

When will a foreign corporation be a CFC?

When US shareholders own more than 50% of the shares, either directly or indirectly, then the foreign corporation will be considered to be a controlled foreign corporation (CFC). To be considered a ‘US shareholder’ the person must own more than 10% of the voting rights or stock value of the foreign company.

When is a foreign corporation a PFIC?

A passive foreign investment company (PFIC) exists when one of the following two conditions are satisfied:

1. Passive investments generate at least 75% of a corporation’s gross income (as opposed to regular business activities); or
2. At least 50% of the corporation’s assets create passive income. Passive income includes interest, dividends and capital gains.

What is a foreign eligible entity?

A foreign eligible entity is defined by whether a member has limited liability or not. This is a default classification under the check-the-box regulations. When all members of the corporation have limited liability the US taxes the foreign eligible entity as a corporation. When at least one member does not have limited liability the entity is not a foreign eligible entity.

An eligible entity may make a check-the-box election to opt out of the default classifications.

Warning on making an election after default classification has been made

It is important to make your election prior to the default classification being applied. This is because making a later election will change the organisation’s classification. Such a change in classification can trigger a liquidation event.

When you should make a check-the-box election:

To ensure the check-the-box election is made appropriately you should consider making the election when you meet all of the following conditions:

1. you own a foreign corporation
2. the US tax system is relevant for your corporation
3. you need to apply foreign tax credits against your US corporate tax regime
4. you wish to avoid applying the CFC or PFIC rules.