At some stage every family business will contemplate branching overseas – either online, export or inbound services.
And at that point that family business will have to think about tax. And we are not talking about Australian tax that we all (supposedly) understand and we have a basic gut feeling about how it should work. When looking internationally the tax systems for the different countries represents, in part, the culture of that different country.
And any part of tax planning overseas will invoke the words “transfer pricing”.
What is transfer pricing?
The concept of transfer pricing is simple. If you are dealing with a person from another country that you control you need to deal with that person on the same grounds as if you would do if you were independent.
Why? Because in the past people have created tax entities in low taxed countries that have charged inflated fees to Australia. The result is that the Australian government gets less revenue and the offshore tax haven gets more income (albeit it at a fraction of the price).
Dodgy Quality Pty Ltd lends $4m to the Jersey Islands (Dodgy Quality Jersey) with no interest charge. The Jersey Islands company then lends the same money back to the Australian group with an interest rate of say 25%.
In this instance the Australian group revenue would fall by $1m even though the economic substance is that the group profit has remained the same.
Transfer pricing tries to fix this. It basically means that the charging of interest to Jersey is commercial and that Jersey back to Australia is also commercial.
The problem with transfer pricing is that it is difficult. International businesses do a range of specialist single purpose transactions that nobody else does and identifying a commercial price is very difficult.
This tax difficulty was overcome by a raft of long (read expensive) documentation showing the costs, risk factors and margins generated by other businesses that are then altered for local factors.
And for many family businesses trying to “have a go” – getting these documents done properly was so difficult that many gave up. Anecdotally we have been told by staff in massive advisory firms that they have never met a business that has found a way to comply.
In effect many family owned businesses, who are so committed to quality and honesty, just decided to wing it and see what happened.
Thankfully this has now changed. The ATO has recognised the difficult provisions and have released “Practical Compliance Guideline 2017/2”. So while it does not mean that you can ignore the law they have indicated that “we will not allocate compliance resources to review the transactions or arrangements specified, beyond reviewing your eligibility to use the option you have applied”.
So basically the police will not look at you. So it sort of has the same effect.
So what are the exemptions?
There are several exemptions – small taxpayers, distributors, intra-group services, low level inbound loans, materiality, management and administration services, technical services and low level outbound loans.
For the purposes of today we will only look at the first – small taxpayers.
You will qualify for the administrative relief if your turnover is less than $25m, you do not have sustained losses, you are not dealing with “tax haven” type countries, you do not pay royalties, no restructures, no licenses or R&D, the related party dealings are not more than 15% of your turnover and you have elected for the administrative concession.
The last concern is important. You must elect in the body of the tax return for the concession. This notification is contained within the International Dealings Schedule of the income tax return.
If your turnover exceeds $25m you might be able to enjoy the simplified concessions as a “distributor” where your turnover is less than $50m. However the requirements for the distributor tax concession are different to those for the small taxpayer concession.
And the concession will only apply in an absolute sense. If you breach one of the items listed by $1: the concessions do not apply to you. So your Perth tax consultant must do a deep dive into your business to understand all of your dealings.
Further, you are still required to keep documentation to prove that the fees are reasonable. And as a tax advisory practice we recommend that Perth clients still keep documentation – the exceptions are quite technical and it is always good to have a fall back provision.
There are other concessions that are also of interest. However it is important to note that families in business can go overseas without incurring a fortune in fees to their tax advisor. Ad if you advisor has affiliated office in other countries you then have the option of not only enjoying simplicity with your own advice: you can also enjoy one piece of advice from your advisor both in Australia and in the country that you are looking at branching into.