Businesses typically have a strong appetite to expand abroad to take advantage of the opportunities on offer, but it can come with a host of new obligations. In a world reshaped by digital business models and the recent pandemic, what do companies need to consider before making an informed decision about new markets?
Businesses are often keen to add to their footprint overseas. International expansion can unlock many benefits, such as increasing brand exposure and customer base, taking advantage of the attractive incentives on offer in certain regions, or enjoying geographical advantages that facilitate an easier flow of goods and services across borders.
But with reward comes a range of risks. When doing business abroad, there's a host of extra requirements and external factors to consider. The decision on which jurisdiction to move into depends not only on the company's intentions, but on the complexity of doing business in the territory from a compliance perspective.
And this complexity can be considerable. For example, there are 82 different VAT rates within the European Union (EU) alone, and 27 different VAT filing and reporting requirements. This helps to explain why a recent industry survey found that over three-quarters of companies have had to increase their attention on tax compliance.
So what should companies be thinking about from a compliance perspective before they make the decision to open up in new jurisdictions?
Preparing to move a business abroad
Businesses expanding into new jurisdictions must be prepared to bear an extra administrative burden in the investment country.
The weight of this burden differs between jurisdictions. According to TMF Group's 2021 Global Business Complexity Index, Brazil, France and Mexico are considered the three most complex places to do business, while Denmark, the Cayman Islands and Hong Kong are the least complex.
It's important to remember that each jurisdiction is free to decide on its own internal policies that are applicable to foreign investors. Again, this differs depending on where in the world you are setting up. To illustrate this point, in terms of transparency, 82% of jurisdictions in EMEA require Ultimate Beneficial Owner (UBO) / People with Significant Control (PSC) information compared to just 43% in Asia Pacific.
Broadly speaking, the most common topics that businesses need to pay close attention to are accounting and tax, HR and payroll, and global entity management (legal) requirements.
In addition to the local rules and regulations that govern each jurisdiction, recent world events have influenced how entities are doing business and making decisions about expanding abroad.
This includes Brexit, which has reshaped politics and business appetite in Europe, and the Covid-19 pandemic, which has led to restrictions and lockdowns that have reduced travel, impacted every industry and increased remote working. Even before the pandemic, the digitalisation of business models was a growing trend that Covid-19 has served to accelerate.
There are pressing questions around the future of work. Some of the world's biggest companies have announced their intention to implement long-term remote working. Remote working has many implications. As well as procedural issues linked to applying for and approving requests to work flexibly, companies must now ensure they consider contractual amendments, changes to individual or corporate tax status, and perhaps even having to establish entities in new locations.
The situation can become particularly complicated if an employee decides they want to relocate. The company then has a responsibility to make sure the employee has the right to work in that new jurisdiction, and that they are complying with the right tax regime.
The tax requirements will be very different if an employee of a company in the Netherlands, for example, decides to move to the warmer climes of Malta. A lack of familiarity with local regulations can result in penalties for both employer and employee.
Understanding the new tax challenges in the digital economy
Wherever a business locates to, it will face a host of different considerations from a tax compliance perspective.
For a start, in July 2021, 132 jurisdictions joined the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting, a new two-pillar plan to reform international taxation rules to ensure that multinational enterprises pay a fair share of tax wherever they operate. This plan comes with a proposed new minimum global corporate income tax rate of at least 15%.
Companies also need to quickly get to grips with the digital transformation of tax administration – referred to by some as 'Tax Administration 3.0'. If one considers Tax Administration 1.0 as paper-based processes and heavy human intervention, and Tax Administration 2.0 as decreasing human intervention supported by the internet, then Tax Administration 3.0 is the embedding of technology into tax and accounting processes with minimal human intervention.
In light of this growing digitalisation, and dependence on data and analytics to enhance tax collection and reduce tax evasion, corporate income tax and VAT are moving further upstream, closer to the taxable transactions themselves. Tax handling in companies' enterprise resource planning (ERP) systems will therefore need to become compliant by design.
This is something that IT specialists can't do themselves – they need the support of local tax technology specialists that understand the requirements of each jurisdiction. Unfortunately, in our experience most organisations don't have tax technology specialists.
Companies that cannot boast the right expertise in-house will need to find the right partner fast. The global tax accounting and compliance picture is complicated, with rules and regulations often very localised. The Portuguese Tax Administration (PTA), for example, requires companies to exclusively use software programs that they've previously certified for issuing invoices and other relevant tax documents.
To conquer the new tax normal, companies must focus on implementing robust, real-time and locally-compliant tax reporting systems. Tax localisation should be high on any multinational's ERP to-do list.
Adapting to the post-pandemic reality – permanent establishment matters
While working remotely, establishing shared service centres and doing business without a physical presence have become more commonplace practices for multinational companies adapting to the new global market, these strategies can be risky and result in unexpected tax exposure.
Host countries can apply the permanent establishment (PE) threshold test, which is present in many countries' tax laws and double tax treaties. Broadly speaking, PE becomes a consideration when foreign companies are deemed to perform sufficient business activities to warrant taxpayer status. This concept has been adopted internationally, but with nuances in different countries.
When performing PE assessments, most tax administrations take physical presence and time spent in the country into account, alongside business activity. The OECD has updated its guidance on the treatment of PE matters due to Covid-19. But these measures are only temporary, in circumstances where public health measures are in effect.
To reduce PE exposure, companies typically need to either register a branch office or incorporate a separate legal entity in the host country. The main difference between these business vehicles is the "legal personality"; a branch office is identified as a foreign investor whereas a legal entity has its own legal personality in the country of incorporation.
Companies need to carefully consider what they opt for. Either vehicle entails certain consequences from an accounting, tax and legal perspective. A legal entity is subject to minimal capital requirements. But it is also subject to the tax laws of the country where it's domiciled, allowing the company to more effectively manage its tax burden and take advantage of favourable tax incentives in a given country or region. Branch offices can typically be set up more quickly but, depending on the applicable tax laws, overall companywide profits may be exposed to additional taxation.
The other implications of operating overseas
While it can be rewarding, entry into overseas markets is a lot of work in terms of taxation and the effective management of financial responsibilities, as well as supply chain complexities.
We've only scratched the surface in this article. Once an organisation has registered for corporate income tax, it needs to work through payroll tax and VAT, work permits, and legal registrations in areas ranging from environmental concerns to data protection. Then there are the local considerations unique to each market, whether it's municipality tax in Hungary or wage tax at the state level in Mexico.
Companies must also ensure they prepare and maintain the correct documentation to support transfer pricing, as well as developing an awareness of any future withholding tax requirements.
Although 144 jurisdictions require IFRS standards for listed entities and financial institutions, local financial reporting frameworks are required for other businesses. Each country has its own financial reporting requirements and entities must understand and apply the local accounting rules appropriately.
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Transnational regulatory reach, local jurisdictional complexity and the risk of non-compliance pose fundamental and ever-increasing challenges for international businesses pursuing commercial opportunities abroad.
At TMF Group, we work with the world's multinationals to help smooth their entry into new markets. Our combination of global reach, local knowledge and multi-disciplinary expertise is your answer to the complex demands of cross-border compliance.
To find out more, make an enquiry today.
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.