Australia is a country full of innovators and entrepreneurs who are stepping out to disrupt existing markets or are creating new ones. While the Turnbull government is doing its best to create a culture of innovation and investment, Australian startups for the foreseeable future will look to the US to relocate operations or establish a base. Investment in startups is increasing, largely thanks to the newly introduced and generous tax concessions, however, there is little that can be done to match the sheer size of the US market or the depth of investors’ pockets. Below, we explain how to flip up your startup to the US as well as highlighting common pitfalls to avoid.
What is a Flip Up?
A flip up is the process of moving your business from Australia to the US so that you’re able to tap into the US market to increase sales, bring on high-quality staff and seek out further investment that may not have been possible in Australia. This is done through the Australian company’s investors swapping their shares for shares in the new US company.
Australian companies that decide to flip up will almost invariably incorporate their US entity in a state with low or flexible corporate tax laws. The most common example is Delaware which is known for allowing companies to operate outside state lines and shift profits or royalties into holding companies within Delaware for tax planning purposes.
Why Would You Flip Up?
While an Australian startup can break into the US market and secure investment, there’s a prevailing school of thought that US companies, consumers and investors will prefer to deal with the structure that they’re most familiar. This reduces costs, legal risk and the general complication of ensuring you comply with the laws of two different countries.
Removing this barrier for potential clients and investors is a big reason why Australian startups have their sights set on a flip up. There is also a strong startup culture in the US, specifically San Francisco and New York, that draws talent to the area.
The Tax Problems
If you’ve setup your business in Australia, then you’ll have a number of existing structures in place holding, among other things, your intellectual property and client base. For almost all software companies these two assets are the very basis on which the bulk of the current and projected values of the company is based. To flip up, you’ll need to decide what you’re doing with these assets. A common option is for the Australian company to retain ownership of the IP and then licence it to the US entity. By licensing the IP to the US entity, rather than selling it, you can avoid up-front tax payments that the ATO may require for the sale of the asset.
Tax Problems When Swapping Shares
Generally, the transfer of an investor’s Australian shares to the US entity will trigger a Capital Gains Tax event, whether it be a gain or loss. While this may occur, some exceptions would allow for a rollover of the CGT liability in select situations. These exceptions allow the investor to put off paying CGT on the sale of the Australian shares until a point in future, such as the US shares are sold. While these exceptions exist, they’re very much based on the particular circumstances of each company and founder. Given the potential consequences if you get it wrong, it’s best to seek professional advice from an Australian tax lawyer or adviser with specialist experience in this area.
Once you’ve worked out whether the potential CGT liability will cripple your plans, you can look to setting up your US entity. As mentioned, Delaware is a common starting point for many Australian companies that land in the US. Once you’ve set up your US entity and relocated your assets, you will still need to be wary of the ATO’s stance on passive entities. If your operations are still based in Australia with little to no activity in the US, then despite incorporating your company in the US, the ATO may view the business as an Australian resident for tax purposes.
Not only will you pay tax at the Australian company rate but if you commence operations in the US, you’ll also be slugged with Australia’s ‘exit tax’. The full move of your operations to the US will result in the Australian business being deemed to have offloaded all it’s CGT assets on the day the US company is no longer an Australian resident company for tax purposes. This can pose significant problems if the market value of your business has increased significantly – something that companies aimed at massive growth (i.e. startups) are prone to do.
Some Good News
Before 1 July 2016, NSW registered companies were subject to a state duty of 0.6% of full market value. Although now abolished, it’s an example of another complicating (and expensive) factor that you must consider when looking to flip up.
Setting Up in the US
Once you’ve been advised on the best way to conduct your flip up from an Australian tax perspective you’ll need to ensure you have the appropriate company structure set up in the US. As mentioned earlier, Delaware is the renown home of many startups and enterprises such as Warren Buffet’s Berkshire Hathaway and tech giant Apple. Although Delaware is a common choice for a company planning to operate in the US, it’s important to seek advice for what best suits your business as the structure (and state of incorporation) is not a ‘one size fits all’ deal.
Once you have received advice on the best structure for your US operations, you’ll need to set up and arrange for the transfer of your Australian company shares. An Australian firm can draft and finalise the share transfer forms/share swap agreement and advise you on whether the proposed transaction is compliant with Australian corporate law. These legal documents will transfer your Australian company shares to the US company in exchange for shares in the US entity.
Importantly, Australian firms cannot advise you on business structuring under US law and as such, you should speak with a US attorney to assist.
Looking After Your IP
Once ownership of your Australian company has been transferred, you can look to start drafting the IP licence agreement that will grant the US entity permission to use your IP. Ensure the licence is appropriately drafted for your intended purpose as investors will uncover any mistakes during their legal due diligence process. Broadly, your IP licence agreement should contain clauses that cover matters such as the purpose of the licence, the term of the agreement and whether it’s:
- An exclusive licence;
- Able to be assigned to another entity;
- Bound to the US or other particular territory; and
- Whether any royalties or fees must be paid.
The size of the US market, quality of engineers and depth of investors’ pockets has a lot to offer the right Australian startups. Before you pay a deposit on an apartment in the Bay Area, it’s important to take a step back and assess all the potential problems and pitfalls that may beset your flip up.
Ensure that you seek professional advice to avoid falling foul of the ATO and to receive tailored assistance according to your current company structure, assets, business plan and future goals. Equally important, make sure that when you do actually execute the transfer that you’re compliant with both Australian and US corporate law to avoid uncertainty over the ownership of your most valuable assets. Questions? Get in touch with our startup lawyers on 1300 544 755.
The tax information contained in this article is not tax advice and should not be relied on as such.
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