It is increasingly common for Australian businesses, particularly those operating businesses online, to try and ‘offshore’ their business. Understandably, they hear media reports about foreign multinationals paying little or no tax in Australia and think, “why not me?”. This article explains the reasons why ‘offshoring’ is not easy and the issues you need to be aware of.
Barriers to ‘Offshoring’
Australian Corporate Tax Residency
The first barrier is Australia’s corporate residency test. Under this test, a company is an Australian resident for tax purposes where you incorporate the company in Australia. However, it is also an Australian resident for tax purposes where you incorporate outside Australia and the company:
- carries out business in Australia; and
- has its Central Management and Control (CMC) in Australia or alternatively, Australian shareholders control the voting power.
Complications Arising From Directors in Different Places
It is important to note that it does not matter whether you appoint a local director if they merely act on your direction and do not exercise independent judgment in that role. Complications can arise where, for example, there are multiple directors in different places. However, it is clear that incorporating a company overseas and continuing as normal does not work from a tax perspective. This does not mean that every offshoring arrangement is tax-driven though. For example, some companies legitimately wish to be closer to their international markets. However, if your company will be an Australian resident, the double taxation problems need to be carefully weighed against any potential business savings.
Considerations When Deciding Whether to Offshore
If you want to offshore your company to another country, such as Hong Kong, you will need to consider:
- if the Hong Kong company will be an Australian resident for tax purposes;
- the tax that needs to be paid in Hong Kong and Australia. The Hong Kong company would pay 16.5% corporate tax in Hong Kong. However, as it is also an Australian resident, the company would also be subject to tax at 27.5% or 30% in Australia, although a foreign tax credit would apply for the amount of tax paid in Hong Kong. Therefore, if the Australian corporate tax rate were 27.5%, the Hong Kong company would pay 16.5% tax in Hong Kong and an additional 11% tax in Australia (which is the difference between the 27.5% tax rate in Australia and the 16.5% tax rate paid in Hong Kong).
- that Australia provides a foreign tax credit for the Hong Kong tax paid. This means that the Hong Kong company will not generate many franking credits. Therefore, the company may not be able to fully frank dividends up to the Australian co-founders (to be taxed at their marginal tax rate).
Jill and Jack are co-founders living in Melbourne who run a successful online retail business. Jack proposes that he and Jill incorporate a company in Hong Kong to sell into the Asian market. Jill and Jack are the directors and shareholders of the Hong Kong company and remain in Australia and all board meetings are held in Melbourne. As they are making high-level strategic decisions for the business in Australia, the Hong Kong company will be an Australian resident for tax purposes.
The Hong Kong company makes a taxable profit of $1,000,000 and the Hong Kong corporate tax is 16.5% or $165,000. Furthermore, the company has paid $275,000 in tax but only generates $110,000 in franking credits and has $725,000 in cash. As a small business at the 27.5% tax rate, it is subject to Australian corporate tax of $275,000 (which, after the $165,000 foreign tax credit results in tax payable of $110,000 in Australia).
When a dividend is paid out to Jill and Jack of $362,500 (plus $55,000 each in franking credits), assuming the top marginal tax rate of 45%, they would each pay $132,875 (after applying franking credits) for a total tax amount on Hong Kong profits of $540,750.
Australia’s Controlled Foreign Company Rules
Even if the company is not an Australian resident for tax purposes, you still need to consider the potential impact of Australia’s controlled foreign company (CFC) rules. The CFC regime is aimed at taxing Australian resident shareholders directly on their share of the income of a CFC.
Broadly, a CFC is a foreign company that is controlled by Australian resident shareholders. In these circumstances, unless the relevant foreign company is in certain countries or satisfies certain tests, the Australian resident shareholders will be taxed on their share of the CFCs income personally.
Offshoring your business is not simply a matter of incorporating overseas. Rather, if you want to remain living and working in Australia, then your company may be subject to Australian tax. It is important to consider the implications of:
- structural double taxation; and
- the loss of (or rather, failure to generate) franking credits when calculating the total tax you need to pay.
If you have any questions about ‘offshoring’ your business or any other inquiries, you can contact LegalVision taxation lawyers of 1300 544 755 or fill out the form on this page.
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