Requirements for overseas representation

Formation of tax haven entities

Ultimate parent company considerations

1. Domestic manufacturer - initial considerations

"Mr S Holmes started Polycon Lens Company many years ago to produce acrylic lenses primarily for magnifying glasses used in the armed services. The company has grown substantially over the years and Mr Holmes' domestic tax advisers have been helping the company reduce its annual corporate tax bill by various different methods, e.g., ensuring that the company falls within a lower band of corporate tax on small profits, obtaining all investment grants and incentives, fully depreciating the company's assets to the maximum amount permitted by tax law, and many other concessions and allowances available."

Requirements for overseas representation

"Recently, Polycon Lens Company has diversified its manufacturing activities and is producing high-quality optical lenses for telescopic use requiring very heavy research and development work, whilst at the other end of the scale, producing inexpensive magnifying glasses for the general public. Mr Holmes does not consider that the company can compete in foreign countries at present in this latter market, mainly because the company cannot produce magnifying glasses in sufficient quantity to enable overheads to be absorbed with a minimum impact on prices. However, he would like to start exporting the optical lenses for telescopic use for this purpose. Mr Holmes considers either opening a small office in Country B, which is geographically suitably placed for penetrating the envisaged market for these lenses, or finding an agent in Country B who will be able to help Polycon Lens Compi1ny achieve the initial export sales target. The actual sales will be effected by the sales representative's of Polycon Lens Company, but the advantages of having overseas representation in the form of a foreign sales office or agent are (a) to provide a fixed base to store a small stock of lenses and to display them in their telescopic application with models to be sent from Country A; (b) to circulate literature to interested potential customers; and (c) to pass on any enquiries or other information which may affect potential sales of the lenses."

At this stage, Polycon Lens Company would wish to avoid creating a taxable presence in Country B; although double taxation may be avoided through unilateral or bilateral provisions, the possible adverse cash flow consequences of paying foreign taxes to be recovered later, and the administrative costs of filing tax declarations would encourage Polycon Lens Company to maintain a low profile in Country B.

Double tax treaties will normally contain provisions establishing when a company is creating a taxable presence in a treaty country (a permanent establishment) as a result of having a fixed place of business there, and when the establishment of an office or agency purely for the purposes described above will not create a tax-resident status for Polycon Lens Company. In our example, Polycon Lens Company ought to be able to ensure that the tax authorities of Country B are not able to assert that part of the profits derived from the export sales are attributable to the representation of Polycon Lens Company in Country B.

"The office in Country B becomes inundated with enquiries and the secretary employed by Mr Holmes threatens resignation unless additional staff are employed. Besides agreeing to employ local staff (principally technicians who would be able to converse with customers in their own language and to explain technical aspects of the lenses), Mr Holmes considers that it would be cost effective to open a warehouse in Country B to expedite orders received by Polycon Lens Company. At this stage, Polycon Lens Company is not sure whether to register in Country B as a branch, or to form a separate subsidiary."

Polycon Lens Company will still wish to avoid local taxation based on profits achieved on the export sales of optical lenses. If the fixed base in Country B continues to be used solely for the purposes of storage, display and promotion, and no sales are affected through it, then no local tax should be levied based on profits derived from export sales. However, the fixed base is now more than a mere representation of Polycon Lens Company in Country B and is now an organisation providing services in Country B; it should therefore earn profits for the rendering of such services, and many tax authorities will insist on a minimum taxable profit of say 10% of total costs incurred by the service organization.

Whether Polycon Lens Company registers the fixed base as a branch, or forms a local subsidiary, may largely depend on non-tax considerations, since the tax liabilities should hopefully be limited. If Country B is a low tax jurisdiction, then Polycon Lens Company may consider establishing a local subsidiary rather than a branch whose profits are subject to domestic tax; it may then think that it can pay service charges to the subsidiary, reducing taxable profits in Country A, which would otherwise be subject to a high tax rate and pay much lower taxes in Country B. However, most countries have sufficient anti-avoidance legislation to redress tax savings artificially engineered in this manner.

It may be helpful to draw up a service agreement between the fixed base in Country B and Polycon Lens Company, which clearly defines the duties required of fixed base B, and limits the scope of its activities. The fixed base B cannot have any authority vested in it to bind Polycon Lens Company or to negotiate and conclude contracts on behalf of Polycon Lens Company. The mere existence of a contract will not however prove that the activities of fixed base B are confined to the same activities, which a purely independent agent would carry out on behalf of Polycon Lens Company in the ordinary course of his business. Sufficient documentation (correspondence, telexes, file notes of telephone conversations, etc.) should be maintained to substantiate the pure service aspect of fixed base B.

If the tax administration of Country B follows the practice of giving tax rulings to confirm the service status of fixed base B, such a ruling will establish the taxable profits as a percentage of administration costs. However, although the ruling may be a comfort to Mr Holmes, the ruling will only apply if the non-trading stipulations mentioned in the ruling are adhered to.

Even though direct taxation may not be a problem for Polycon Lens Company, indirect taxation (value added tax) may result in an irrecoverable cost element; the incorporation of a local company, which is registered for value-added tax, may recover input tax from the tax authorities, which Polycon Lens Company could not otherwise achieve.

Date: 2015-01-29; view: 805