Do you or your business organisation receive income from overseas investments or businesses, or are you or your business organisation intending to invest overseas?
If so, you need to be aware of the potential for a "double tax whammy" being imposed on these foreign profits. Careful consideration of all aspects of the investment structure is necessary to ensure that you are not paying more tax than you need to.
A tax issue which is often not considered by Australian investors when structuring an Australian investment into a foreign country is a tax-efficient repatriation of foreign profits back to Australia.
Investors often focus on structuring their investments into a foreign country in a manner which minimises foreign tax payable on foreign profits derived from their investments. This is the case whether the foreign profits are rental income from a foreign property, or business income from a foreign business operation.
In our experience, investors are often unaware that their investment structure can give rise to double taxation when foreign profits are repatriated back to Australia.
Specifically, the foreign profits may be taxed once by foreign revenue authorities when they are derived by the foreign company and then taxed again by the Australian Taxation Office (ATO) when the profits are repatriated back to Australia.
The following scenarios highlight this issue:
Australian individual purchases shares in a foreign company
Peter is an Australian tax resident. He owns an Australian company which runs a successful business.
Peter would like to invest overseas, and proceeds by acquiring shares in a foreign company which operates a business in that foreign country.
The foreign business is successful and the foreign company derives A$10m of foreign profits. The foreign company pays foreign tax at the local corporate rate on these profits and declares the remaining amounts as dividends to its shareholders, including Peter.
If the foreign company is not a controlled foreign company, the foreign dividends received by Peter should be included in Peter's Australian assessable income together with Peter's other Australian income. If Peter's other Australian income exceeds $180,000, the foreign dividends will be subject to the highest Australian tax rate of approximately 45%. There is no credit for the underlying corporate tax paid overseas.
If the foreign company is a controlled foreign company and Peter is an attributable taxpayer, he will be assessed by the ATO on his portion of the A$10m of profits in the income year that those profits were derived from the foreign company. Peter would generally be able to claim the foreign tax paid by the company on these profits as an Australian tax offset. When Peter's portion of the A$10m of profits which is already assessed by the ATO is subsequently declared as a dividend by the foreign company, Australian tax will not be payable on the dividend.i
In both situations, foreign profits that are passed to Peter are taxed by foreign authorities and taxed again by the ATO.
In the former situation, Peter's portion of the foreign profits was subjected to foreign corporate tax and Australian tax at a rate of 45%, with no credit for the underlying corporate tax paid overseas.
In the latter situation, Peter's portion of the foreign profits was subjected to foreign corporate tax and Australian tax at a rate of 45%. However, Peter was able to claim the foreign tax paid as a tax offset against his Australian tax payable.
Australian individual has shares in an Australian company which invests overseas
Peter uses his Australian company to purchase shares in the foreign company.
The foreign company derives A$10m of foreign profits, pays foreign corporate tax on these profits and declares the remaining amounts as dividends.
On the basis that the Australian company controls 10% or more of the voting power in the foreign company, the dividends received by the Australian company will not be subject to Australian tax.ii
Australian individual has shares in an Australian company which expands its active business overseas
Peter's Australian company expands its business in a foreign country.
If the proposed investment vehicle is a wholly owned company (i.e. a subsidiary), the dividends received by the Australian company should not be subject to Australian tax.iii
If the proposed vehicle is a foreign branch office and not a company, the foreign profits derived by Peter's Australian company should also not be subject to Australian tax, provided that certain requirements including the following are satisfied:iv
- The foreign operations must constitute a permanent establishment.
The definition of a permanent establishment for Australian tax purposes can vary from country to country, but it is generally defined to include a place of management, a branch, an office, a factory and a workshop located in the foreign country whereby its agents can conclude contracts on behalf of the Australian company.
- The business carried on by the foreign branch office is an active (rather than a passive) business.
In both Scenarios 2 and 3 foreign profits repatriated back to Australia were neither subject to Australian tax nor double taxation. This is in contrast to Scenario 1.
Provided the foreign profits repatriated back to Australia are managed, double taxation of these profits can be avoided. By way of example, the foreign profits which have not been subject to Australian tax can be used to fund the Australian company's business operations.
If you are an individual or a manager of a business currently contemplating an investment into a foreign country, we recommend that you discuss these scenarios with your tax accountant and/or your tax lawyer and ensure that all Australian and foreign taxation aspects, including a tax-efficient repatriation of profits back to Australia, are properly considered.
iSection 23AI of the Income Tax Assessment Act 1997.
iiSection 23AJ of the Income Tax Assessment Act 1997.
ivSection 23AH of the Income Tax Assessment Act 1997.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.