Formation of foreign sales subsidiary

"Polycon Lens Company achieves some success with its export sales but after a couple of years, it comes to the conclusion that it cannot achieve its full potential without having sales representatives based overseas that do have the ability to conclude sales. Although Country B has been useful for the service organisation, it is considered that Country C provides more facilities for a direct selling operation and Mr Holmes establishes the Luna Technics Company for this purpose."

Polycon Lens Company will again be faced with the decision of whether to form a branch of Polycon Lens Company or a local subsidiary in country C, and besides the many non-tax considerations which apply, as before, it also has to seriously consider the tax implications of the different forms of entities.

Country C may have been chosen partly because it offers special tax concessions to sales companies, which may take the form of customs duty concessions because of Freeport status, reduced rates of corporate tax on profits earned by those companies importing goods solely for re-export and similar tax concessions to off-shore trading companies, those companies whose activities are totally carried on outside Country C or to exporting companies.

Alternatively, Country C may itself be a pure tax haven where no Corporate Taxes are levied on profits earned, or it may be a low tax country whose standard rates are far lower than those of many other countries discussed in this book.

Mr Holmes would naturally be interested in any concessions which reduce the foreign tax payable on Polycon Lens Company's export sales, even if the tax administration of Country A will eventually levy the same high level of corporate tax on such profits; the lower direct tax bill initially provides a real cash flow advantage and tax deferral is often as valid as tax avoidance. If Country C offers tax concessions to Luna Technics Company, then Mr Holmes will be tempted to ensure that the prices charged for the optical lenses from Polycon Lens Company to Luna Technics Company permit the maximum profitability in Luna Technics Company rather than in Polycon Lens Company. The anti-avoidance legislation, which is specifically aimed at inter-company pricing, must be carefully considered, and the basis on which tax administrations may adjust the taxable profits for artificial pricing policies must be fully understood.

Because of the possibility of inter-company pricing adjustments, Polycon Lens

Company may like to consider financing Luna Technics Company by means of consignment sales, which would only be transferred into the ownership of Luna Technics Company at the moment of sale to third parties. In this way, unrealised profits within the "group" would not be assessed to tax in Polycon Lens Company by means of a pricing adjustment, and only realised sales would be open to investigation by tax administrations.

Application may have to be made to the authorities of Country A for permission to transfer the trade (previously carried on by Polycon Lens Company) to Luna Technics Company; the basis on which consent may be forthcoming should not rest on the avoidance of domestic taxation.

Where the actual sales activities are carried on in other countries, and the establishment of sales subsidiary Luna Technics Company has primarily been for tax purposes, Luna Technics Company must avoid liability to tax in other countries as a result of contracts concluded with residents of those countries. If Luna Technics Company establishes any base in another country from which its sales activities are co-ordinated, then the profits earned as a result of sales with residents of that country may be subject to foreign tax; this is commonly referred to as the "trading within" as compared to the "trading with" concept. Foreign taxes may therefore be incurred if Tax Havens sales are concluded in that country, or if the title to the goods concerned passes in that country; moreover, if Luna Technics Company is an offshore trading company, then the place of effective management may be considered to be within one or more foreign countries, and the entire taxable profit attributable to the export sales of optical lenses, may be subject to foreign taxes other than those imposed by Country C.

The overseas sales subsidiary may be useful for Mr Holmes' personal tax planning. First, Mr Holmes may be able to pay expenses from Luna Technics Company which may otherwise be carefully scrutinised by the tax administration of Country A. Secondly, Country A may give special concessions to citizens/residents of that country who are working either partly or wholly outside Country A during a tax year. Mr Holmes may also of course require several other companies or forms of legal entity for his personal tax planning.

If Country. C is a high tax jurisdiction, but levies a lower rate of tax on companies with small profits, Mr Holmes should ensure, wherever possible, that the profits of Luna Technics Company and Polycon Lens Company (if a small companies rate or a graduated rate is also applicable in Country A), fall below the prescribed limits. He should also check that a subsidiary of a foreign company is entitled to a lower corporate tax rate if applicable, or that, if a branch is registered rather than a company, Polycon Lens Company can obtain the benefits of the lower tax rate applicable to domestic companies on branch profits.

The non-discrimination clause of most treaties will normally require that a branch or a corporation owned by a nonresident in a treaty country will not be subjected to a more onerous tax bill than a domestic company in the same circumstances. If the local law in country C stipulates that branches of foreign companies are subject to an additional tax on profits, as compared to local corporations, the non-discrimination clauses of tax treaties may provide treaty protection. If there is no tax treaty, the creation of an intermediary company resident in a treaty country with C, which then operates through a branch in Country C, may prove beneficial.

Mr Holmes has clearly formed a subsidiary, Luna Technics Company, for commercial considerations to increase Polycon Lens Company's export potential. Whether or not Luna Technics Company is also formed for tax purposes, it should take advantage of any local concessions that are offered. They may include similar deductions and allowances as mentioned above when considering Polycon Lens Company's domestic tax position. A local tax expert should be used for each country to maximise the after-tax profits, which may be distributable to Polycon Lens.

It is also important that Polycon Lens Company's tax position is considered when preparing the accounts of its subsidiary. For example, if initial losses can be shown in the accounts of Luna Technics Company, as adjusted for Country A's tax legislation, and the concept of residence in Country A is management and control, then it may be advisable to claim initially that Luna Technics Company is managed and controlled by Mr Holmes and his staff in Polycon Lens Company, so that it is fiscally resident in Country A. The claim for group relief may enable the losses of Luna Technics Company to be offset against the taxable profits of Polycon Lens Company. Alternatively, the tax legislation of Country A may permit the deduction of losses incurred by overseas subsidiary companies from domestic taxable Income.

An alternative is to adjust the prices for which the lenses are purchased from Polycon Lens Company or to transfer expenses in Luna Technics Company to Polycon Lens Company. Such tax planning must be capable of substantiation if transfer-pricing adjustments by the tax authorities are to be avoided. Where losses cannot otherwise be offset against taxable profits elsewhere, and there is a limitation on the number of years for which losses may be carried forward, then Luna Technics Company must have the means to refresh these losses prior to their expiry.

Polycon Lens Company may attempt to secure a double deduction of losses initially incurred by the sales operation in Luna Technics Company as follows; initially, Polycon Lens Company operates in Country C with a branch, so that its losses are offset against taxable profits in Polycon Lens Company and then, prior to profitability, the branch is converted into a company and losses transferred to the company may then be offset a second time against future profits. Mr Holmes should be aware that the transfer of a foreign branch into a subsidiary company might involve Polycon Lens Company in a substantial tax liability.

Date: 2015-01-29; view: 827