Successful Australian startups often launch quickly into Asian markets. However, with international expansion comes decisions on business structuring and international tax which can support or hinder your future plans and profitability. These include issues relating to transfer pricing, foreign subsidiaries & foreign branches.
If you’re expanding internationally, one of the first decisions you’ll have to make is whether to structure your overseas business as a foreign branch or a foreign subsidiary. Your choice will depend on many different factors, such as how your business model is set up, which country you want to invest in and what activities you want to pursue in that country.
The decision about whether to structure your overseas business as a foreign branch or subsidiary is important as it will influence how your profits are taxed, what income tax reporting requirements your company must follow, and which ‘transfer pricing’ (ie international tax) obligations arise. Transfer pricing is a challenging tax compliance issue if you’re operating in more than one country.
We briefly explain the transfer pricing requirements that apply to foreign branches v subsidiaries, but firstly, some definitions you need to understand.
Foreign branch, foreign subsidiary & transfer pricing
A foreign branch is an integrated part of your Australian business that is located overseas, for example a foreign office or sales unit. For tax purposes, a foreign branch is often called a ‘permanent establishment’.
A foreign subsidiary is your other alternative. A foreign subsidiary is a separate independent entity that is owned and controlled by your Australian company. This means that it is registered as a company, its profits are assessed separately, and it has to lodge its own income tax return in its country of residence. Profit distributions and other payments paid to your Australian company can be subject to a withholding tax. Whether these payments are also taxed in Australia depends on the existence of a Double Tax Agreement (DTA) between Australia and the other country.
Transfer prices are the prices that related companies apply to their internal transactions. Australian tax law requires that these transactions are priced are as if they occurred between non-related parties – This is called the ‘arm’s length’ principle. This not only applies to the intercompany sale of goods and services, but to all transactions that occur between related parties.
Australian transfer pricing law and requirements
When non-related parties have dealings with each other, each party will theoretically try to negotiate a price that satisfies their own economic interests. This is basically how market prices come into existence. Because your foreign subsidiary is controlled by you (through your Australian company), you have the power to influence pricing. Transfer pricing legislation aims to ensure that prices between related parties reflect market prices – in other words: are at arm’s length. To enforce this, the ATO requires you to keep transfer pricing documentation to substantiate your transfer pricing policy.
Most Australian businesses with foreign subsidiaries will need to carry out a transfer pricing study (often called a ‘Transfer Pricing Manual’) to determine whether your transfer prices are at ‘arm’s length’. This manual should contain a description of your business and all the related parties in your company group, an analysis of the Australian and global industry in which your business operates, and a benchmarking study to determine the arm’s length range in which your transfer prices should lie. See more detail here on Australia’s transfer pricing requirements.
The ATO allows qualifying entities to opt-out from Australia’s full transfer pricing requirements. However, documentation is still required to prove your eligibility. See the Simplified Transfer Pricing Record Keeping’ (STPRK) options available here.
Transfer pricing for foreign branches
For transfer pricing purposes, branches are not considered to be interrelated parties. This means that some of the transfer pricing documentation requirements do not apply to transactions between your business and your foreign branch. However, profitability should be apportioned between each jurisdiction to replicate the profitability which would have been arrived at, if these were separate entities at ‘arm’s length’.
In addition, you first have to determine which functions of the business are performed by the branch (or permanent establishment) and which are performed by your Australian company. Based on this analysis, you then may need to carry out a benchmarking study (but not a full Transfer Pricing Manual) to determine arm’s length considerations for the functions performed.
Avoid international tax risks
Cross-border activities are a core focus of the ATO’s review activity, and its easy to put yourself at risk when your entities and the requirements seem a little blurry. We have encountered startups that brushed away international taxation issues, only to see their brilliant profit-making enterprise turn to dust overnight when the ATO confirmed that there were additional hidden tax costs. It’s essential to seek professional advice to ensure you are compliant with Australian legislation and the transfer pricing rules for your foreign subsidiaries or branches.
Accru Felsers is a strong supporter of start-ups and has successfully helped many businesses take their first steps in Australia and grow to the next stage overseas with great success. While we are global business specialists, we can scale our specialist international tax services for smaller businesses. Read about our transfer pricing services or contact Will Merdy, our startup and growth specialist, for initial advice on expanding your business overseas.