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Outbound investments – how should you structure your expansion overseas to avoid 70% effective tax rates and withholding tax leakage?
Outbound Investments
Imagine you want to expand your business overseas. How do you avoid tax leakage. And avoid entering the overseas tax system?
This is the question Simon Calabria of Webb Martin Consulting in Melbourne will discuss with you in this episode.
Here is what we learned but please listen in as Simon explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Outbound Investments
In Australia your top marginal tax rate is 45% + 2% Medicare. Sounds astronomical but when you expand overseas, that is often the best case scenario. The worst case can be effective tax rates of 74% or more, take this example.
Example
Let’s say you expand into the US and set up a 100% C-Corp blocker with a 79% C-Corp interest.
And so now your US C-Corp trading entity pays 21% federal income tax, distributes to your blocker and your blocker pays 21% federal income tax on the net dividend again. Let’s assume state taxes are 9%, so of $100 profit, $49 arrive in cash in your Australian bank account. At least there is no withholding tax, but your effective tax rate up to here is already 51%.
The $49 arrive in your Australian holding as NANE per Subdiv768A ITAA97, so no corporate income tax to pay. Sounds good but the ATO isn’t done with you yet.
When you distribute the $49, there is no franking credit and so marginal tax rates apply to the $49. If your marginal rate is 45%, you pay another $23.03 including Medicare. So all up you paid $74.03 in tax on your $100 of original profits. Can you see why structuring this properly is important?
So here are some general rules to get your structure right.
General Rules
US
1 – No imputation system, so every C-Corp pays 21% federal tax + state taxes.
2 – If 80% or more, you can consolidate and avoid double taxation.
Conclusion: Only stack C-Corps if 80%+ or don’t distribute profits.
3 – LLC is taxed like a partnership, so shareholders get taxed.
Conclusion: LLC is an easy way to avoid double US tax. Have an AU or US blocker.
4 – US withholding tax is 0% WHT if 80%+, 5% WHT if 10% to 79% and 15% WHT if less than 10% held.
Conclusion: Depends on DTA. The big question is who gets a FITO in Australia for the US WHT.
5 – Capital gains from the sale of US shares are not taxed in the US if sold by US non-residents as long as the US entity doesn’t hold land.
Conclusion: Foreign investors in the US pay a lot more tax on US business profits than on the sale of a US business.
Australia
1 – Profit distribution: If the Australian company holds 10% or more, any profit distribution is NANE in Australia, either per Subdiv 768A when an overseas company or per 23AH when an overseas branch.
2 – Capital gain: If overseas company and the active foreign business asset percentage is 90% +, the capital gain is NANE per s768-520 ITAA97.
3 – Capital Gain: If overseas branch, the capital gain is NANE per s23AH(3) ITAA36.
Conclusion: All this NANE talk sounds awesome, but wait until you distribute. Then you are hit with marginal tax rates. And no franking credits or 50% CGT discounts to soften the blow.
4 – Withholding tax: All entities get a FITO for the WHT they pay, but companies have withholding tax leakage since FITOs don’t hit the franking account, so dividends subject to WHT arrive without franking credits in the hands of the ultimate shareholder.
Any Company
When you structure your overseas expansion, focus on both ends of the spectrum. You have the business operations overseas on one end and the business owners in Australia on the other end – now draw a line between these.
If you put a company anywhere onto this line between the business operations and the individuals, then you have tax leakage.
And it doesn’t matter whether the company is in Australia or overseas. It doesn’t matter whether the company is a trading company or just a blocker. And it doesn’t matter what type of company it is – using the US as an example – whether it is an S-Corp or a C-Corp or an LLC that makes a corporate election.
Any company will give you tax leakage if placed between the business operations and the individuals.
But if there is no company between the overseas business and the ultimate owners, then you don’t have tax leakage because any tax the owners pay overseas, they can claim back as a foreign income tax offset, a FITO.
So if you put the overseas entity into individual names or a partnership or trust – in other words the individuals pay the overseas tax, then these individuals can claim the FITO. And as long as you can claim a FITO, you have no tax leakage.
United States
So specifically using the example of the US, if you put the business in the US into a C-Corp or use a C-Corp blocker and/or hold the US interest through a holding company in Australia, then you have leakage. Because whatever tax you pay in the US, the ultimate owners won’t get a FITO. So they will pay full tax again – mind you on the net amount – but nevertheless full tax.
But if you put the US business into an LLC and then hold that interest in individual names or through a trust, then you can claim a FITO for any tax you pay in the US – be it a corporate tax or withholding tax.
And so this is what we will look at in the next US episode when we talk with Bryan Kelly of Withers in San Francisco. What are the US tax implications when your Australian trust holds an interest in an LLC in the US that is treated like a partnership for tax purposes, so you don’t make a corporate election for this LLC?
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 15 November 2021
Tax Talks spoke to Simon Calabria - Director at Webb Martin Consulting - for more details.
