Declaring Foreign Business Interests

Navigating the U.S. tax code can feel like tiptoeing through a minefield, especially when you throw in international dealings. 

If you’re a U.S. person or corporation with foreign business interests, two forms in particular—Forms 5471 and 5472—might already haunt your dreams. 

Dubbed the “Terrible Twosome” by some beleaguered taxpayers, these forms come with stringent filing requirements and draconian penalties for non-compliance. 

Here’s why you should never forget to file these forms, what the consequences of forgetting are, and some recent developments that might surprise you.

What Are Forms 5471 And 5472?

Form 5471 is essentially an information return that must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. 

The form requires detailed disclosure about the foreign corporation’s income, assets, and shareholders.

Form 5472 on the other hand, is used by U.S. corporations that are at least 25% foreign-owned, or by foreign corporations engaged in a U.S. trade or business. 

This form requires disclosure of reportable transactions between the reporting corporation and related foreign parties.

While both forms may seem like just another piece of paperwork, failure to file them—or filing them incorrectly—can lead to massive penalties.

The Fines:

Staggering and Unforgiving The IRS takes non-compliance with Forms 5471 and 5472 very seriously, with penalties that could make even the most seasoned tax veteran wince. 

For Form 5471 the penalty starts at $10,000 per year per foreign corporation. 

If the taxpayer fails to correct the omission within 90 days of being notified by the IRS, additional penalties of $10,000 accrue every 30 days, up to a maximum of $50,000. 

Form 5472 penalties are even harsher, starting at $25,000 for each accounting period the form is not filed. 

After the IRS sends a notice of failure, an additional $25,000 penalty kicks in for each subsequent 30-day period of non-compliance, with no cap on the penalties. 

These penalties apply whether the non-compliance was willful or due to an innocent mistake, although options for relief exist in cases of non-willful conduct. 

However, this relief is often difficult to obtain and requires demonstrating reasonable cause for the failure. 

No Statute Of Limitations? Yes, You Read That Right

One of the most terrifying aspects of failing to file these forms is that it can leave your entire tax return open to scrutiny indefinitely. 

Normally, the IRS has three years from the date you file your return to audit it. 

However, if you fail to file Forms 5471 or 5472, that statute of limitations does not apply. The IRS could theoretically go back and audit that return 10, 15, or 20 years later. 

Recent Developments: A Small Ray of Hope?

A recent Tax Court case, Farhy v. Commissioner, had thrown a wrench into the IRS’s penalty regime. 

In April 2023, the court ruled that the IRS did not have the statutory authority to assess penalties under Section 6038(b) for failing to file Form 5471. 

The IRS had been enforcing these penalties for years, but the court found that there was no legal basis for these assessments.

However this Tax Court Ruling was subsequently overturned by the United States Court of Appeals, District of Columbia Circuit on  3 May 2024.

Conclusion: Don’t Tempt Fate

If you have foreign business interests and think you might need to file Form 5471 or 5472, the best advice is simple: file them. 

Even if the forms are a headache and the rules seem complex, the potential costs of non-compliance—financial and otherwise—are simply too high to ignore. 

And as the Farhy case shows, while there may be occasional victories against the IRS, they are the exception rather than the rule. 

So, stay vigilant, keep those forms in mind, and avoid becoming another cautionary tale in the annals of tax non-compliance. 

The “Terrible Twosome” might be formidable, but with careful attention and professional guidance, they don’t have to be your undoing.

For many people the United States is a major investment jurisdiction.

Whether that investment is made into stocks, bonds, managed funds, real estate or shares in US private companies – the size and scale of the US market is often irresistible for international investors.

One of the downsides of investing directly into the US can be that non-residents of the United States who own U.S. assets can be subject to U.S. estate tax.

This can significantly impact their estate planning strategies by imposing a significant cost on their estate.

This article discusses the exposure of non-residents to U.S. estate tax, the benefits of estate tax treaties, the relevance of international wealth in estate tax calculations, and the formalities required to transfer U.S. assets to beneficiaries. 

U.S. Estate Tax for Non-Residents

Non-residents of the U.S. are subject to estate tax on their U.S. situs assets, which include real estate, tangible personal property located in the U.S., and certain intangible assets such as stocks of U.S. corporations. 

The tax rates range from 18% to 40%.

Importantly the exemption amount is significantly lower for non-residents than for U.S. citizens and residents, currently only $60,000.

Estate Tax Treaties

The U.S. has estate tax treaties with several countries, including Australia, Canada, France, Germany, Italy, Japan, the Netherlands, South Africa, Switzerland, and the United Kingdom. 

These treaties can provide several benefits, including:

Unified Credit

Some treaties allow non-residents to use the unified credit available to U.S. citizens, which can significantly reduce the estate tax liability. 

Exclusions And Deductions:

Treaties may provide for exclusions of certain types of property or deductions for debts, taxes, and expenses.

Relief From Double Taxation:

Treaties can prevent double taxation by providing rules for the allocation of taxing rights between the U.S. and the treaty country.

Relevance Of International Wealth

For non-residents, the U.S. estate tax is generally limited to U.S. situs assets.  

However, the international wealth of foreigners can still be relevant in certain situations.

For example, under some treaties, the U.S. may consider the decedent’s worldwide assets to determine the allowable unified credit or to apply pro-rata deductions. 

Example Calculation (Singapore Resident: No Estate Tax Treaty With US)

The non-resident owns a $1,000,000 U.S. property and has no debts or other deductions: 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Exemption Amount: $60,000 

3. Taxable Estate: $940,000 

Using the U.S. estate tax rates, the estate tax liability would be calculated based on the progressive rates. 

For simplicity, assume the effective tax rate is around 34% for this taxable estate size: 

Estate Tax Due: $940,000 x 34% = $319,600

This is major cost on a deceased estate and something that can be planned for ahead of time.

They key point here is to be aware of strategies to minimize or eliminate US estate tax.

Example Calculation (Australian Resident: Estate Tax Treaty With US)

The U.S.- Australia Estate Tax Treaty can provide relief and reduce the tax liability. 

Consider an Australian resident who owns a $1,000,000 U.S. property and has $5,000,000 in worldwide assets. 

The unified credit for U.S. citizens in 2024 is $13,000,000. 

1. Gross Estate: $1,000,000 (U.S. property) 

2. Worldwide Estate: $6,000,000 

The proration of the unified credit is calculated as follows: 

Prorated Unified Credit = U.S. Situs Assets/Worldwide Assets  X Unified Credit

Prorated Unified Credit = 1,000,000/6,000,000 x 13,000,000 = 2,166,66 

The effective exemption amount is $2,166,667. 

 3. Taxable Estate: 

Since the U.S. situs assets ($1,000,000) are less than the prorated unified credit ($2,166,667), the taxable estate is reduced to zero. 

 4. Estate Tax Due: 

 With a taxable estate of zero, the estate tax liability is also zero.

Formalities For Transferring U.S. Assets

For those beneficiaries of deceased estates that have to deal with the transfer of U.S. assets from a deceased resident to a beneficiary, the following steps are required:  

1. Obtain A Transfer Certificate: 

The IRS requires a Transfer Certificate (Form 5173) to release the U.S. assets. 

This certificate ensures that all applicable estate taxes have been paid or secured. 

2. File Form 706-NA: 

The executor must file Form 706-NA, U.S. Estate (and Generation-Skipping Transfer) Tax Return, to report the U.S. situs assets and calculate the estate tax due. 

3. Pay Estate Tax: 

Any estate tax due must be paid. 

In the above examples, in Singapore the estate tax due is $319,600. Whereas in the case of the Australian estate no tax is due. 

4. Submit Documentation: 

Provide the IRS with necessary documentation, including the death certificate, will or trust documents, and appraisals of the U.S. assets. 

 5. Transfer of Title: 

Once the Transfer Certificate is obtained, the executor can proceed with the transfer of title of the U.S. assets to the beneficiaries as per the deceased’s will or trust documents. 

Conclusion

Other strategies exist to manage this exposure, including the formation of trusts in certain US states to hold assets.

The key point here is to plan the way you hold your U.S. assets as early as you can.

Indeed, those people who are non-residents of the U.S. holding US assets from countries that do not have an Estate Tax Treaty with the U.S. have the most severe exposure.

Please contact us to discuss any concerns or questions you might have with respect to holding US assets.

The United States tax code presents a labyrinth of rules and regulations, particularly for U.S. residents with investments in foreign corporations. These complexities are magnified when dealing with Controlled Foreign Corporations (CFCs) and the associated immediate taxation of foreign earnings under Subpart F or the Global Intangible Low-Taxed Income (GILTI) regime. This article delves into Section 962 of the Internal Revenue Code (IRC), explaining its significance and utility for U.S. tax residents in managing their foreign investments more effectively.

The Challenge: Immediate Taxation of Foreign Earnings

For U.S. tax residents with investments in foreign corporations, including those held through pass-through entities such as partnerships and S corporations, immediate taxation of foreign earnings is a significant challenge. This taxation arises annually under the Subpart F or GILTI regimes, compelling taxpayers to include foreign income in their U.S. taxable income, often leading to double taxation without relief mechanisms available to corporate taxpayers.

Corporate vs. Individual Taxpayer Treatment

The tax burden disparity between corporate and individual taxpayers under the GILTI regime is stark. U.S. corporations benefit from a reduced federal income tax rate of 21 percent, a Section 250 deduction that allows them to deduct up to 50 percent of GILTI, and the ability to claim up to 80 percent of foreign taxes paid as a foreign tax credit. This combination of benefits significantly mitigates the impact of GILTI on corporate taxpayers.

Conversely, U.S. resident individuals are generally taxed at a federal income tax rate of up to 37 percent on GILTI, without access to the Section 250 deduction or foreign tax credits for GILTI. This discrepancy creates a substantial tax burden for individual taxpayers, necessitating a strategy to level the playing field. This is where Section 962 of the IRC comes into play.

How Section 962 Election Works

A Section 962 election allows U.S. individuals to elect to be taxed on their GILTI and Subpart F income at corporate tax rates. When an individual makes this election, they are effectively treated as if they own their CFC through a hypothetical domestic corporation. This election provides several advantages:

1. Corporate Tax Rate: The taxpayer is subject to the 21 percent corporate tax rate instead of the higher individual rates.
2. Section 250 Deduction: The taxpayer can avail the Section 250 deduction, reducing GILTI by 50 percent.
3. Foreign Tax Credit: The taxpayer can claim an indirect foreign tax credit for taxes paid on the CFC’s net income in the foreign country, up to 80 percent of the foreign taxes paid.

Practical Example Of Section 962 Election

Consider a U.S. individual who wholly owns a CFC in Germany with net tested income of $1,000 for GILTI purposes, having paid $150 in foreign taxes. Without a Section 962 election, the individual faces a 37 percent tax rate on GILTI, resulting in $370 of U.S. tax, without any foreign tax credit or Section 250 deduction.

However, with a Section 962 election:

• The income is taxed at the corporate rate of 21 percent.
• The individual can deduct 50 percent of the GILTI under Section 250, reducing the taxable income to $500.
• Adding back the $150 foreign tax paid (gross-up), the taxable income becomes $650.
• Applying the 21 percent corporate tax rate results in $136.50 of U.S. tax.
• After claiming 80 percent of the $150 foreign tax as a credit ($120), the U.S. tax liability is reduced to $16.50.

Future Distributions And Tax Implications

The tax advantages of a Section 962 election extend to future distributions. In the example above, when the taxpayer eventually receives a distribution of $1,000 from the CFC, it will be taxed at the qualified dividend rate of 20 percent plus the 3.8 percent Net Investment Income Tax (NIIT), resulting in $238 of U.S. tax. Without the election, distributions would typically be subject to ordinary income tax rates, leading to higher tax liabilities.

When To Make A Section 962 Election

Despite its benefits, a Section 962 election is not always advantageous. Some scenarios where the election might not be beneficial include:

1. Same-Year Repatriation: If the CFC’s earnings are repatriated in the same year, the benefits of the election may be negated.
2. State Tax Considerations: Not all states follow the federal tax treatment. States like California do not tax Subpart F or GILTI until a distribution is made, meaning the Section 250 deduction and foreign tax credits may not be available for state tax purposes.
3. Future Tax Increases: Future distributions from previously taxed earnings under a Section 962 election might be taxed at higher rates, potentially offsetting the initial benefits.

Conclusion

Section 962 of the IRC offers a powerful tool for U.S. tax residents with investments in foreign corporations to manage their tax liabilities more effectively. By allowing individuals to be taxed at corporate rates and claim deductions and credits typically available only to corporations, this election can significantly reduce the tax burden associated with GILTI and Subpart F income. However, the decision to make a Section 962 election should be based on a careful analysis of individual circumstances and potential future implications. Consulting with a tax professional is essential to navigate the complexities and determine the best tax strategy.

The US has similar payroll tax requirements to Australia. From withholding taxes on wages, to payment of payroll taxes assessed on wages paid, and lodgement of employee forms, there is a range of compliance requirements that your company must fulfill.

There are a wide variety of payroll tax considerations, including tax withholding and taxes payable on the amount of wages. These taxes are levied to fund social security, Medicare, unemployment and disability benefits, and other State and Local requirements.

Withholding Taxes

• Employers are responsibility for withholding taxes from wages and paying this to the Federal government.
• Some States also require withholding taxes to be withheld in relation to the income taxes on employee wages.
• Employers must typically make regular payroll tax deposits and file quarterly payroll tax returns with the IRS.
• State and Local tax agencies often have their own reporting and payment requirements.
• Withholding taxes go towards the individual employee’s income tax obligations.

Payroll Tax Requirements

Federal Insurance Contributions Act (FICA) Taxes

• Funds social security and Medicare.
• Social security tax rate is 6.2% for the employee plus 6.2% for the employer.
• Medicare tax rate is 1.45% for the employee plus 1.45% for the employer.
• Additional Medicare is payable at 0.9% for the employee when their wages exceed $200,000 in a year.

Federal Unemployment Tax Act (FUTA) Taxes

• Funds state workforce agencies and unemployment insurance.
• FUTA is payable by the employer and is calculated at 6% on the first $7,000 paid to each employee.
• Payment of state unemployment taxes can often be used as a tax credit to bring the FUTA tax rate down to as low as 0.6%.

State Payroll Taxes

• State Payroll Taxes may apply depending on the location of your business.
• The most common State tax is State Unemployment Tax (SUTA), which is payable by the employer.

Local Payroll Taxes

• Additional payroll taxes may be payable based on the zip code, county or municipality where your business is located.

Employee Forms

• At commencement of employment, employees fill out a Form W-4. This guides employers on how much income tax to withhold.
• At the end of each year, employers must provide employees with Form W-2, which reports the employee’s annual wages and tax withholdings.
• On commencing employment, employers are required to verify an employee’s eligibility to work in the US. This is typically done through the I-9 Form.

Other Payroll Considerations

• Workers Compensation Insurance
• State Disability Insurance
• Paid Leave
• Health Care Costs for Employees
• Retirement Plan Contributions 
• Reimbursements and Stipends

Penalties For Missed Or Late Payments

The IRS may charge a late fee for employment taxes that are not paid on time. This is called a “Failure to Deposit Penalty”.

Payroll tax penalties are:

• 1-5 days late: 2% of the overdue payment
• 6-15 days late: 5% of the overdue payment
• Over 15 days late: 10% of the overdue payment
• More than 10 days from first notice: 15% of overdue payment

Other Employee Benefits

Other Employee Benefits you may be required, or choose, to pay, can include:

Retirement Plans

One of the tax advantageous retirement savings plans is known as a 401(k). Under this plan you would pay a percentage of each paycheck into your employee’s retirement savings account instead of directly to them.

Health Insurance

Employers must offer affordable health insurance that provides minimum value of 95% to full time employees (working 30hrs or more a week) and their children (until they turn 26).

Stock and Stock Options

Stock and stock options can be offered as a form of equity compensation.

The US has a complex tax system, with multiple taxes, including income taxes, often being imposed on a State level as well as a Federal level. Some types of taxes also apply locally, meaning that even within the same State you can pay very different taxes to other parts of the State.

• The US Corporate tax system operates on a Federal, State and Local system. This means taxes and other compliance costs may be charged from all three levels.
• Filing requirements, lodgement deadlines, and available deductions or credits often differ between locations.
• Due to the complexity of Local variances, compliance with the Local tax laws requires specialised Local knowledge for the area or areas in which your business operates.
• To optimise your corporate tax strategy, it is recommended that you consult with experienced tax professionals who have a Local understanding of US taxes, as well as international taxes.
• Tax returns are typically based on a calendar year.

Choosing Your State

Since every State has different laws, it can be important to select the right State for your business operations. You will be required to register in every State that you operate in, however if you have no particular business requirement for which State or States you operate in, then it can be advantageous to select a State that has more well known and simple tax laws.

For instance, Delaware has no state income tax, a fairly straight forward tax system, and well-known corporate laws across the US.

Types of Taxes

Income Taxes (Federal And State)

• The Federal tax rate for companies is 21% 
• 44 States levy corporate income taxes. These taxes vary from 0% to 11.5%, with some states assessing taxes on a flat rate and others using tax brackets in the same manner that individual income taxes are assessed.
• 43 States levy state income taxes, 41 tax wage and salary income, New Hampshire exclusively taxes dividend and interest income and Washington only taxes capital gains income. Seven states don’t impose any individual income taxes. Some states use a flat income tax rate, while others have a graduated tax rate depending on the individual’s income.

Sales Taxes (State And Local)

• Sales taxes are similar to GST or VAT in certain parts of the world. However, as sales taxes are only imposed on a State level, the rates vary between 0% and 7.25% depending on the State.
• There are also various Local governments within 35 States that impose an additional sales or use tax, which ranges from 1% to 5%.

Property Taxes (State And Local)

• Local authorities such as cities, counties, and school boards, typically impose property taxes on the value of the property, including the land and the structure on the land.
• Each State imposes different parameters on property taxes.
• Property taxes can also be payable on purchase and/or sale of property.
• Most States have a “homestead” exemption which reduces or eliminates the cost of property tax on your primary residence, subject to a variety of qualifications or limits, which vary State to State, or even within States.

Payroll Taxes (Federal, State And Local)

• Federal payroll tax is paid by both the employer and the employee.
• Some States and Local authorities also require some form of payroll tax to be paid. The most common type is State Unemployment Insurance (SUTA tax), which is payable by the employer.

Franchise Of Privilege Tax (For Doing Business In A State)

• Some States require certain business organisations to pay a franchise tax, otherwise known as a privilege tax, for doing business in the State.
• This tax is typically calculated on the net worth of capital held by the entity.
• Some States use an economic and physical presence test to determine whether a business is taxed, while others have no written interpretation of the basis of their test for determining who is required to pay the franchise tax.

Gross Receipts Tax (State)

• Some States apply a gross receipts tax on a company’s gross sales, without consideration of deductions for expenses.
• Gross receipts tax applies to businesses, regardless of whether sales relate to business-to-business transactions or business-to-consumer transactions.

Business Licenses (State, Local, With Some Federal Regulations)

• Business licences or permits may be required on a Federal, State, or Local level.
• Business licenses can take some time to be processed, and they should be completed prior to commencing operations. The complexity of the application depends on your industry, as well as the locality managing the license.
• Licences and permits typically need to be renewed on a regular basis.

Due to the complexity of the wide variety of Local, State, and Federal taxes, it is important that you obtain qualified advice regarding your business. If your business expands into additional locations you will need to get updated advice regarding the new location in which you are operating.

Expanding to the US means you are entering a complex tax system. From international tax concerns, to different Local, State, and Federal requirements, there are many factors to consider. The type of legal structure you choose will impact your compliance and tax considerations obligations.

Type Of Entities

C Corporation (C Corp)

• Separate Legal Entity that works like an Australian private company does.
• Offers some asset protection due to legal structure.
• Taxed at the corporate level and when profits are distributed as dividends, these are taxed in the hands of shareholders.
• Has Directors, shareholders (stockholders) and a separate tax identity to the shareholders.
• Federal income tax rate is currently 21%. State income taxes may also apply.
• In some instances dividends may have a reduced withholding rate of 5% when paid to foreign shareholders.
• Allows for capital raising, new shareholders or selling the business completely by selling shareholdings to new investors.
• High compliance requirements including meetings, quorums, minutes, and other management formalities.

Limited Liability Company (LLC)

• This is a simplified form of a company. In operation it is similar to an Australian partnership where control is in the hands of the members and profits flow through to the owners rather than being taxed at the entity level.
• Provides similar protection, and more flexibility than a C Corp.
• LLCs are not managed by Directors. They are managed by the members or an appointed Manager.
• It is possible for an LLC to have a sole member.
• Members do not need to be US residents.
• Tax returns need to be filed if there are two or more members, however the profits are distributed to the members who pay tax on their share of the profits.
• Can elect to be taxed as a C Corporation instead of being taxed in the hands of the members.
• Can elect how profits are distributed to members. For instance, profits may be split equally between members, based on capital contributions, or in other agreed ways.
• If foreign tax is paid on the profits to an Australian member, they can claim the foreign tax paid as a tax credit on their own assessment of profit distribution received.

Branch (No New Entity)

• No separate legal entity, meaning Australian entity is directly responsible for tax and compliance requirements.
• Branch profits may be subject to US tax as well as Australian tax, depending how the branch is established in the US. In this instance the Australian company can typically claim the foreign tax paid as credits to reduce the impact of double taxation.
• As there is no additional entity there may be less compliance issues to consider with transferring profits from the US to Australia. 
• Whether you need to establish a US entity or not, will depend on the nature of the business you are operating.

Taxation Issues To Consider With Your Chosen Legal Structure

Both Australian and US tax laws need to be considered regardless of the legal structure used to establish the US business operations. International tax issues will also need to be considered where members, Directors or owners remain residents of Australia.

Australian Taxation

• If the US entity is controlled in Australia it may be treated as an Australian tax resident.
• The Australian parent company will need to consider how the fees paid between the US and the Australian entities are taxed in Australia.
• US generally imposes a 30% withholding tax on payments to foreign entities.

US Taxation

• The US may tax income earned from any business established in the US, regardless of whether the operating company is a US or Australian resident.
• Australian resident members or Directors may be subject to US taxes before considering Australian taxes on income generated from the US branch or entity.

Fees Between Entities

• US transfer pricing rules require transactions between related parties to be at arm’s length. This means that the value of fees may be adjusted where it is not arm’s length.
• Proper documentation is essential for consulting or management services between entities, including basis for fees charged. This can assist in ensuring that fees paid between the US and Australian entities are treated as required for tax purposes.
• Fees must be ordinary and necessary business expenses in order to be tax deductible to the paying entity.

Planning a move overseas is a big step, no matter where you are going. There are different social expectations, legal rules, business regulations, tax requirements, and more to figure out.

You need to determine whether you or a key team member is going to make the physical move to head up the overseas expansion, and facilitate this move to be as smooth and efficient as possible. 

Then there are business decisions such as deciding whether to set up a brand-new company, or trade overseas directly under your head company. While there are too many factors to consider in one article, and it is essential to get tailored advice for your situation, you can get a head start by considering an overview of the key concepts that you will need to cover.

1. Operation Zones

Companies in Dubai can choose to operate as free zone companies, offshore companies, or Mainland companies. This decision will have an impact on where you can do business.

If Dubai is going to be your hub for regional or international commerce, then a free zone entity may be the best option. This is because Free Zone Companies can only operate within their Free Zone and abroad, not on the mainland. However, if you are intending to provide goods and services to the UAE, then a Mainland firm would be the required option.

Free Trade Zone Company

There are over 40 zones throughout the UAE that are Free Trade Zones. These zones have special tax, customs, and import regimes. Businesses operating within these Free Trade Zones may be exempt from paying corporate tax as well as import and export taxes. However, they are restricted from doing business with the Mainland.

Mainland

A Mainland business can be set up in Dubai or any other emirates, so they can operate in the UAE as well as internationally.

Offshore Company

If your company is incorporated in the UAE offshore, you can operate with minimal capital requirements and operate on an international basis.

2. Income Taxes

From June 2023 all companies operating in the UAE under a commercial licence are taxed after the first 375,000 AED of their net profits. The tax is charged at a flat rate of 9% and only applies to the profits above this first 375,000 AED. This makes it one of the more appealing corporate tax rates in the world.

Note that Free Trade Zone companies may continue to be exempt from paying corporate tax under their specific free zone incentives. 

In line with the Global Minimum Corporate Tax Rate agreement, multinational firms with profits exceeding EUR 750 million, will have to pay 15% tax. 

From June 2023 businesses operating under the new rules now need to register with the Federal Tax Authority and lodge tax returns for the business on an annual basis.

3. VAT and Excise Tax

Since 2018 a goods and services tax, or a value-add tax, known as VAT, has been applicable at a flat rate of 5%.

There are some exclusions to which items incur VAT, including exports of goods and services, international transportation, some education and healthcare services, investment-grade precious metals, and new construction of residential properties. Some Free Trade Zeons are also exempt from paying VAT for trade within their zones. 

In 2017 the UAE implemented an excise tax. This is an indirect tax that is imposed on goods that are considered to be harmful to either personal health or the environment. This includes a 50% tax on carbonated drinks and a 100% tax on energy drinks and tobacco products.

4. Employer Responsibilities

As an employer you are responsible for paying your employees under the local employment rules and regulations. There are a range of responsibilities that you are required to cover for your employees, including:

• Paying wages in accordance with local laws and regulations. This includes proper job documentation, conditions of labour, and paying wages on time. As there is no individual income tax there is no tax withholding regime to consider.
• Providing health insurance for employees. This is a compulsory requirement for all employers.
• Under UAE law the employer is responsible for paying the travel and recruitment costs, including entry visa, of any employee they are recruiting or moving to the UAE.

5. Moving To Dubai When Expanding Your Business

A visa residency through employment is required for any individual moving to Dubai for work purposes. Note that it is the employer’s responsibility to organise and pay for an employment Visa.

The standard work Visa lasts for two years. This requires an employer sponsor to confirm employment in Dubai.  

A “Green Visa” is applicable for freelancers or self-employed individuals. This requires specialised educational qualifications and evidence of your annual income to prove financial solvency. This Visa is for five years.

Finally, the “Golden Visa” is a residency permit that allows foreigners to live, work, or study in the UAE for 10 years without a sponsor. Investors, entrepreneurs, and more can apply for this Visa. This Visa also allows the immediate family to be sponsored so they can move to Dubai as well.

It is also important that individuals moving to Dubai are aware of local expectations, laws, and requirements, which may be vastly different from your home country.

6. Other Business Responsibilities

As with running a business in any other location, there are essential rules, regulations, licensing, and other requirements that your business needs to be aware of as part of your setup and operation.  Some of these are listed below.

Bank Account

It can take two to four weeks to open a bank account for commercial purposes. While the required documents vary according to the bank and the type of account you open, the Business Manager will need to have their own residency visa in order before you apply.

Trade Licence

Every business that operates in the UAE must have a trade licence, or a business licence. This may be a commercial licence, a professional licence, or an industrial licence, depending on your business activity.

Business Entity

You can set up your business as a sole proprietorship, an LLC company, or a branch office. If operating from a Free Trade Zone your business can be 100% foreign-owned.

7. Double Tax Agreements (DTAs)

The UAE is expanding their list of DTAs throughout the countries of the world in order to facilitate strategic global partnerships. These agreements help ensure that the consequences of being taxed in multiple tax jurisdictions is mitigated via exemptions or reductions in taxation on investments from profits.

While the USA does not have a DTA with the UAE, there is currently a DTA between the UAE and Singapore, as well as the UAE and the UK. Australia is in the process of establishing a DTA with the UAE. 

8. Property Taxes

Although there is no capital gains tax or inheritance tax in the UAE, there is a transfer charge on the transfer of property within the UAE. The rate of charge varies in each Emirate, with a 4% charge applying in Dubai. This transfer fee is typically paid by the buyer of the property.

9. Rental Tax

Although there is no individual income tax in Dubai, there is a rental tax. The tax on rental properties varies between Emirates. In Dubai commercial tenants pay 10% and residential tenants pay 5%. In some locations citizens are exempt from the rental tax.

Foreigners In The UAE

As there is no income tax for individuals, both residents and non-residents of the UAE are not required to lodge an income tax return in the UAE.

However, if you remain a resident of your home country then you will need to lodge a tax return in your country of residence, and this may require the inclusion of income earned from the UAE.

Depending on how your business in the UAE is set up, you may also be required to report this income as foreign income in a local company tax return.

Local Taxation Experts

As there is no individual income tax and corporate tax is new to the UAE, there may be limited access to accountants, and limited experience with the UAE tax regime on a local level.  

It is therefore especially important to seek the advice of International Tax Experts who can help you navigate the new requirements in Dubai, as well as the impact of doing business across multiple borders.

CST have been assisting Australian and expat clients for over 30 years. Helping businesses to set up overseas and connect with local tax experts is an essential part of the support we offer clients around the globe. With the UAE now introducing a corporate tax into their tax regime it is more important than ever that you get the right advice for your expansion into Dubai. 

In today’s world we have incredible opportunities to build our business beyond our own shores and reach into expansive international markets. Indeed, the number of expats is growing so fast that if all the expats were members of a country, it would be one of the fastest growing countries in the world.

The United Arab Emirates (UAE) is one of the most popular destinations for expats. As of 2023 the UAE is called home by approximately 10.2 million people. A staggering 85% of the individuals who comprise that population, are expats. When you look at why Dubai is an attractive market for businesses, it’s not hard to see why this temptation to join the shores of the UAE is hard to pass.

In this article we’ll look at the appeal of Dubai as a destination to expand your business to, and what you need to know when you’re ready to expand your business to Dubai.

The Appealing Business Market of Dubai

The simplified and diversified economy of Dubai makes it an attractive place to set up your international business. Some of the key reasons that Dubai is particularly appealing include:

1. Minimal Tax Regime In The UAE

One of the most appealing benefits of doing business in Dubai is a minimal tax regime. Company taxes are low and there is no income tax on individuals and no capital gains tax. 

2. Free Trade Zones

The UAE includes a number of Free Trade Zones, with about 20 located in Dubai. Free Trade Zones are geographical locations where people from any other country can come in and set up their international business, without requiring a local connection. Businesses located in Free Trade Zones can operate their business within their zone and internationally. Each Free Trade zone has their own rules, regulations and incentives. 

This differs from Mainland zones. Mainland Zones have more rigorous entry requirements, including local sponsorships, before your business can set up and operate. These Zones are regulated by the Department of Economic Development (DED). However, a business operating in a Mainland Zone is able to trade within the UAE, as well as internationally.

3. A Robust, Yet Simplified and Diversified Economy With A Strong Exchange Rate and Access To Resources

Balancing a safe and robust standard of governance, with minimal taxation responsibilities,       Dubai offers a world-class infrastructure and is well known as a world-class financial hub for business operations. The local economy is strong and the UAE has a solid exchange rate. 

As a popular location for expats around the world, there is also a rich and diverse supply of experience and professional skills on location. 

Furthermore, the local government is a strong advocate for developing ideas and facilitation of growth and progress. As a technologically advanced nation, Dubai also has access to significant beneficial resources.

4. Limited Restrictions and Regulations On Your Company

There is no restriction on capital repatriations. This means that your company can return any investments to foreign owners, without limitations. 

Share capital requirements are minimal, with no minimum amount of capital required for limited liability companies. This ensures that your company can be established with the flexibility to suit your purposes. 

Unlike many countries, there is no requirement to have a physical office established to operate in Dubai. 

Due to the minimal amount of regulations, when compared to other onshore jurisdictions the costs of setup in Dubai are low.

5. Geographically Ideal Location

Geographically, Dubai provides a strategic position for businesses looking to expand to the Middle East, Europe, Asia and Africa. As such it is an ideal location to set up a range of businesses including import/export, logistics, tourism, and more. 

For transportation, Dubai offers access to the largest sea and airports in the world.

6. Strong Connections With the Worldwide Economy and Worldwide Business Standards

The UAE has signed up with the Common Reporting Standard (CRS), as part of the global standard for the exchange of information, including allowing countries to exchange tax data between participants. This helps with the prevention of fraud, and aids in the management of business matters across international borders. 

In essence, Dubai is an appealing place to run a business because of the ease and convenience of doing business there, solid business standards, access to resources, and the simple and low tax regime that applies.

Many private clients heading to abroad may already have a trust in their home country or a 3^rd Country.

Historically trusts have been attractive vehicles because they offer people the potential of protecting their wealth from external attacks, but it can also help lower the burden of taxation on a family group.

For those who do not have a trust as yet but who are considering establishing a trust, a great deal of thought and planning needs to go into it.

We make sure our clients understand the four golden rules of setting up a trust:

1. Ensure the bank or financial advisory firm managing your money does not own the trustee company that will be the trustee of your trust. This prevents a conflict of interest.
2. Understand how you can unwind the trust arrangement.
3. Recognise that long-term solutions require tax contingency planning before you sign on the dotted line. As your residency can change, so can your tax position.
4. Make sure you understand how you can access trust income and/or capital to pay taxes that may become due on the gains of the trust.

Before delving into some further issues associated with trust management, I will cover just a few central points about how trusts work for those who may not have worked with trusts.

How Trusts Work

A trust is an arrangement whereby a trustee has a fiduciary obligation to deal with property over which they have control for the benefit of one or more beneficiaries who are able to enforce such an obligation.

Beneficiaries may be individuals, corporations, or indeed other trusts (such as a charitable trust).

All trusts have a trust deed. 

At a high level, this is a document that outlines the rules that the trustee must follow in relation to the property they control.

Common objectives for utilising trusts are to protect assets and ensure that beneficiaries are deable to benefit financially from the trust in a manner that suits the family group and in accordance with the wishes of the settlor of the trust.

The discretionary trust is the most common trust used by business owners and investors. 

They are generally set up to hold family and/or business assets for the benefit of providing asset protection and tax-planning benefits for family members.

The Trust Deed: Its Importance

The trust deed is the most important document of a trust as it establishes and defines terms and conditions upon which the trust must be operated and managed.

More specifically, the trust deed sets out the beneficiaries of the trust, as well as the end date of the trust and the conditions upon which the trustee holds the property for the beneficiaries.

Actions undertaken outside the provisions set out in the trust deed can be deemed by a court of appropriate jurisdiction to be null and void. 

The implications of an action being null, and void can reach further than the act simply being treated as if it did not occur.

An invalid act of a trustee can result in unwanted taxation implications for the trustee, and a breach of the trustee’s duties can lead to personal liability for damages or alternatively unwanted consequences for beneficiaries.

The best approach in dealing with trust management and planning is to treat every trust deed as unique and therefore refer to the provisions in the deed prior to taking any action.

How Are Trusts Taxed?

While a trust is regarded as a taxpayer in some countries (e.g., Australia), in other countries this is not the case. 

In some countries, the beneficiary is taxed on gains accruing in the trust; in others, it is the original settlor who suffers the tax burden.

Changing Residency With a Trust

One aspect of trust management and planning to get right when you have a trust is to ensure that assets are not unwittingly ‘exported’ into certain tax jurisdictions when you change your tax residency status.

If you want to set up a trust, then before you move to a particular country it is important to understand how a trust determines its residency status under the laws of that country.

In Australia, a trust is regarded as a tax resident of Australia if one of the trustees is a tax resident of Australia. 

However, in other jurisdictions, the concept of central management and control of the trust is used to determine the residency status of the trust.

It is important to work through all the residency aspects likely to impact your trust when you move around with an existing trust.

The key point to note is that it can be a useful exercise to transfer assets from an individual to a trust prior to changing residency and heading overseas. 

However, like most things, this strategy has its pros and cons.

Trusts Heading Overseas: Residency Determination

In the Australian context, where an individual trustee of an Australian trust changes residence, then, often, the trust will also change its residence.

In these cases, you need to make sure that when the trustee changes its residence, the tax consequences are identified.

Before you depart you need to consider whether it is beneficial to you and your family for the trust to stay a resident in your home country where it was established or if it makes sense for the trust to move with you to your new country.

If the immediate and ongoing tax consequences of keeping the trust in its particular form are not advantageous to you then we can discuss alternative strategies with you.

Such strategies may include replacing the trustee of the trust with a company that is domiciled in the jurisdiction to which you are moving and make the trust subject to the laws of that jurisdiction. 

In other situations, it may be more appropriate for a replacement trustee to be appointed in a third jurisdiction and have the trust reside in a 3^rd country.

The purpose of the discussion here is to highlight the fact that planning for a departing trust is very important.

Our approach to this area is to recognise that trusts are long-term family vehicles, and just because a client may move to a new country, it does not mean that they should have to wind up their trust and forgo all the benefits that it has provided them.

Given our international tax and trust knowledge, we will be able to help our client make important decisions such as this.

Trusts Arriving Abroad

Moving around the world while being in control of trusts is complicated and should not be done lightly.

Arriving in another country with a trust and no plan is a recipe for disaster.

Where a new individual client has changed their residence and they are the trustee of a foreign trust, it is clear that this trust is also likely to become a resident of the arrival country.

In other cases, even if the client ceases being the trustee before they change their residence specific jurisdictions tax income on ‘pre-migration transfer of assets’ to foreign trusts. 

It is also likely that the trust deed may need a review as some of its definitions and terms may have no meaning in the new country the trust is being exported to.

Even if the trust is residing in a 3^rd country, a review of the trust deed from the perspective of the laws of the new country is warranted.

Other concepts, which might be recognised abroad, such as ‘community title’, might be used in the trust deed, but these concepts might have no application in the arrival country.

The arriving trust may still have reporting obligations in the country in which it was established. 

It may also be the case that there are foreign protectors or other people who have an ongoing role in the management of the trust.

You should consider how they are affected in terms of reporting based on the country you are moving to.

This is particularly important if the arriving trust has a business or significant assets.

Often, the cost base of trust assets must be understood on the day the trust first enters a new country.

Usually this will be the market value of the assets on the day of the trust’s arrival, but not always.

While your move abroad is an exciting time for most people and full of challenges and new opportunities, considering the tax issues of how your trust would be affected by your move is essential.

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.