Expanding operations abroad is usually the privilege of companies that have been around for a long time, but IT and tech companies can find themselves becoming international at a very early stage in their lifecycle.
Aside from the worldwide demand for innovation and IT solutions, many tech businesses develop an international presence through cloud activities, which by their nature span many countries and tax jurisdictions. So businesses of this kind may find themselves establishing a base very quickly in numerous countries across the world.
A budding tech company setting up abroad can face some unanticipated problems when it comes to accounting for taxes. These include fulfilling local tax requirements, registering your profits overseas, providing funds to set up part of your business abroad, and organising the rules of trade between your businesses.
Understanding local tax laws
When you’re first setting up your business abroad, no matter how unintentionally or innocently you may go about it, there’s a distinct chance you’ll slip up when it comes to local tax laws.
Opening up an office abroad for any longer than around six months for example, could make you liable for accounting requirements including local tax returns. So the office you set up may start out as simply a point of contact overseas, but if you’re performing certain tasks that make that office a substantial part of your business then that could be considered a taxable base.
A company that realises it should have been completing tax returns on its business abroad can find itself in hot water, and the consequences of this can be significant in certain countries. Unfortunately it’s not just a case of saying ‘sorry, here they are.’ If you miss the due date on your tax returns, what you could end up paying is not just the initial tax amount, but any penalties owed for not completing the tax returns, as well as interest owed from the deadline date.
Seeking local tax advice is paramount for any business that sets up abroad, to make sure you meet the accounting requirements of the country.
Avoiding transfer pricing
A UK business opening up overseas also needs to think carefully about transfer pricing. If you decide to open a subsidiary of your company, which is a separate legal entity to your business, in a country with no corporation tax, you might think it’s best for the majority of your profits to occur in that country. But most tax authorities would see this situation as falsely moving your profits or ‘transfer pricing.’
You need to make sure you have a fair profit registered in the UK or HM revenue will make an assessment on what the fair profit would be and charge tax accordingly.
And if you sell the products or services that your company supplies from your holding company to your subsidiary, you’ll need a transfer pricing agreement, which again you’ll need guidance on.
Funding your business abroad
When you’re starting out overseas, quite often the company you set up will need money. If you make a loan to your company abroad, you need to be aware of the tax implications both at the time of the transaction and further down the line.
It’s important to clarify how you provide that money and how long you provide it for. Your business will need to keep track of this transaction because if, for whatever reason, that money can no longer be paid back, there’s a chance you won’t be eligible for tax relief.
The problem can amplify if you decide to sell to your company overseas, rather than provide a loan, that way you have a trade debtor and a trade balance. If the overseas company cannot pay the trade balance, or the balance is unpaid for a long period of time, then HMRC won’t provide tax relief when you come to write off the balance, as they consider it to be something called ‘thin capitalisation’.
At 20%, tax relief would make the cost of the debt much smaller to write off. This could make a real difference to small IT and tech companies starting out in an international setting.
Setting out formal trade agreements
If your business decides to offer funding to set up a branch or subsidiary abroad, then it’s a good idea to set out a formal trading agreement to detail how that transaction will play out. This can accompany a transfer pricing agreement.
Although these formalities may seem superfluous at first, by documenting more than you need to, you will have your decision-making processes laid out if any part of your tax documentation is questioned. This can significantly reduce any penalties that are raised against you.
A formal trading agreement is also helpful for laying out how the different branches of your company interact with each other and the territories in which they operate. It’s usually the case that your offices overseas are run by separate directors. Naturally, verbal conversations can be misunderstood between these parties and agreements could come into question at a later date.
If it’s in writing then having that rationale could alleviate potential problems later on.
For more information on Chris Cairns, visit Alliotts.
If you’re an IT or tech business and you’re interested in learning about how tax could affect you, you can view the previous articles in this series by using the links below.
Take care of all aspects of your business with Business Insurance for IT Consultants