Top Five Tax Considerations for Australian Companies Expanding to the United States
Tax Law - 22 Dec 2021
ABA Legal Group’s specialist tax and corporate law team has created this list to assist those businesses looking to expand their operations into the world’s largest economy, the United States of America.
Expanding into the US is undeniably an exciting key milestone in any business. However, from a legal planning perspective, it is crucial to be proactive in planning, to minimise the chance of surprises from both the US legal and corporate environment, and the complexities that attach itself to international tax.
We’ve outlined some of the most common considerations that arise when a business is expanding to the US, to help give you a head start on optimising your structure – whilst still playing by the rules!
Of course, as your fun-loving/innovative/not-your-typical ‘lawyers’, we must caveat that the commercial drivers and facts of every business are different and as such there is no one size fits all when contemplating how to structure your US expansion.
1.) Choosing a business structure in the United States
We would like to begin by saying that starting your business in the US, without setting up a business structure in the US, can itself lead to US tax problems. So, it is critical to seek help early to ensure you can hit the ground running with the most appropriate structure for your business.
Choosing a business structure in the US is dependent upon your commercial drivers and goals, and must consider the particular circumstances of your business, as different entities have different tax treatment and requirements. The two most common US business structures for expansions from Australia are:
2. Limited Liability Company (LLC).
C-Corporations are most easily compared to an Australian company. There is a separation from the shareholders and the company itself.
However, the US does not have an Australian equivalent of our ‘franking system’. Consequently, there is an element of double taxation, once at the company level and again at the shareholder level when they receive the company’s profits. The flexibility of a C-Corporation is the ability to retain and reinvest profits. Being a separate legal entity, the C-Corporation pays income tax on its profits and can retain and reinvest these profits.
By comparison, a LLC defaults to a flow through tax treatment, where the income and expenses of the LLC flows through to the members for tax purposes. Despite this tax treatment, the LLC is otherwise treated as a company with the corporate veil and asset protection implications from this.
2.) Choosing to be taxed as a different business structure
An LLC may an election, known as ‘check-the-box’, to be taxed as a different business structure. There are certain advantages that may arise by electing to be taxed differently, such as the benefit of a fixed corporate tax rate and minimising additional compliance and disclosure obligations.
There will be trade-offs between an LLC with flow-through tax treatment and a check-the-box election. The key is to be aware of these trade-offs in order to decide on the most appropriate structure.
3.) The United States Tax System
The US imposes taxes at a federal, state and local level. Federal income tax is imposed at a fixed rate for companies and at a rate based on taxable income for other entities. State income tax is also imposed on taxable income where such income has a sufficient business nexus with that state. Therefore, whilst you may choose a state to incorporate in based on a number of reasons, if your target market is in another state, you still may be subject to tax in that other state. A range of local taxes are also imposed, which differ based upon the particular local district.
Although the US does not impose federal goods and services tax (GST), most states and local municipalities impose a sales tax on the sale of goods and services. This can sometimes extend to digital sales tax, bringing online sales from any country that sell to US residents into their tax net.
4.) Australian Considerations
Even once you’ve decided on the best US structure for your business, you need to consider the operation of Australia’s tax and regulatory systems.
Under a company structure, if central management and control of the business (i.e. the key decision making and control of the business) is being exercised in Australia, the company risks being treated as an Australian tax resident (and subject to tax in Australia on its worldwide income). At worst, your US business could be subject to tax in the US and in Australia on the same income.
Additionally, if certain thresholds relating to control are met, Australian shareholders can be taxed in Australia on income of the US company on an attribution basis, before it is physically paid to the shareholder. This provision is only aimed at taxing Australian shareholders that are holding investment income offshore to defer tax in Australia – if your business is genuinely carrying on business the risks levels should be lower.
5.) Transactions between your Australian business and United States business
Transactions between related parties in Australia and the US has the effect of moving income and expenses between the two countries but within the one corporate group. With different rates of tax this risks inappropriately stripping profits from one country to the other.
These risks are mitigated through transfer pricing rules in both Australia and the US’ tax laws. The transfer pricing rules are incredibly complex, but at the highest level the rules require that any related party transactions between the two countries must represent an arm’s length outcome, which is the outcome that unrelated parties would be expected to negotiate. For example, if a bank would lend your US subsidiary funds at a 3% interest rate, loaning funds from your Australian entity on the same terms but with a 10% interest rate is likely to raise red flags.
Overlaying this is the Double Tax Agreement (DTA) between Australia and the US. The DTA is intended to avoid double taxation, where both countries seek to tax the same income. Using the above example, where the US company pays interest (at 3%, to comply with the transfer pricing rules!) to its Australian parent, the US may seek to tax the interest as it was paid in the US, while Australia may seek to tax the interest as it taxes the Australian parent’s world wide income. The DTA addresses this by saying the US may tax the interest but only to a maximum tax rate of 10%, while Australia may tax the dividend at normal Australian rates (generally 25% for a small business entity), but must allow a tax credit for the US tax paid.
The operation of the transfer pricing rules and the overlay of the DTA to each transaction between related parties can be incredibly complex, but we have the skills to decipher the rules, to explain them to you in ordinary language and to assist you to develop the most appropriate structure for expanding operations into the US.
Co-written by Ally Evans.
The information contained in this blog is general in nature and should not be considered to be legal, tax, accounting, consulting or any other professional advice. In all cases, you should consult with a professional advisor familiar with your factual situation for advice concerning specific matters before making any decisions. By reading this blog, you confirm your understanding of this disclaimer.