Some tax risks of expanding your business in other countries
Most companies will experience the same steps when they want to conquer a new market for their products. They will first try to achieve a lean and mean ‘landing’ by cooperating with a third party before opening its own corporation in that country. An example: suppose company Airbreeze BV sells high tech air ventilation systems in 10 countries within the European Union. One of the new markets Airbreeze BV wants to focus on, is South-Africa. An old employee (Mr. Jackson) who left the firm a couple of years ago to work for a competitor in Africa, just started his own company (Jackson Pty Ltd) in Johannesburg and offered to focus on Airbreeze BV’s products.
In a board meeting the decision has been made to come to an agreement with him where he will sell the ventilation products in South-Africa for Airbreeze BV. Mr. Jackson created his corporation in South-Africa and started working and selling Airbreeze BV’s products. Per sold product he receives 20% of the sales price. This structure was recommended by Airbreeze BV’s advisor since the tax risk was now actually being limited to zero. Jackson is after all an independent agent working in the ordinary course of his business. And the one thing Airbreeze BV’s board wants to avoid is the creation of an unexpected tax liability in South-Africa.
Well, in practice the created solution seems not to be so reliable as being suggested by Airbreeze BV’s advisors. Under the new international tax rules which are expected to come into force somewhere in 2018, an independent agent (Jackson Pty Ltd) who is actually performing commercial activities which are subject to detailed instructions or to comprehensive control by Airbreeze BV , cannot be regarded as independent of the enterprise. Since Jackson Pty Ltd is focusing on Airbreeze high tech products, it can be expected that there will be detailed instructions and comprehensive control. As a consequence Airbreeze BV could end up with a permanent establishment in South-Africa. And this is not all.
Apparently Jackson Pty Ltd is doing quite well. Already in the second month of its existence the proposal has been accepted by one of the country’s biggest hospitals in Cape Town to use Airbreeze’s air ventilation systems in a newly build hospital in the other part of the town. Airbreeze BV produces the requested systems and ships them to Cape Town. A team of specialized engineers will move to South-Africa to do all the fine-tuning and installation. Since installing the system has to take place partially during the construction of the hospital, the installation lasts a little more than 13 months, South-Africa is entitled to tax part of the profits. Besides the additional compliance obligations a negative tax effect can arise due to the little higher tax rate in South-Africa and probably due to a different approach of what the taxable basis is under South-African tax rules.
To conclude, corporations have to take tax risks into account as a consequence of new international tax rules. The above examples are just two of the many.
If you want to know more about tax risks your company incurs by starting new activities across the border, please contact us: firstname.lastname@example.org