- Permanent establishments
- Company incorporation
- Corporate tax residency
- Dividend imputation and other corporate law issues
You may recall from issue 3 of this series that scoping the market is an important starting point in taking your first steps into Australia. When emerging markets and opportunities have been identified, the obvious question becomes “so what next?”
The focus of this issue is on building your Australian presence. We touch on some important taxation considerations in relation to establishing Australian‑based operations, with a particular focus on incorporating an Australian company.
Practically speaking, acquiring or leasing physical premises such as a warehouse, a factory and office space immediately come to mind when establishing an Australian presence. The less immediate (but nonetheless important and potentially overlooked) consideration is the potential taxation implications associated with these initial steps.
Enter the concept of “permanent establishment” (PE). You may recall this concept, as well as Australia’s double taxation agreements (DTAs) from issue 3 of this series in a secondment of staff context.
As the name suggests, a PE generally means a fixed physical place of business such as an office, branch or factory. It can also extend to mines, installations and other sites in existence to extract natural resources.
Broadly speaking, Australia cannot tax the business profits of an enterprise of a country with which it has a DTA unless the enterprise carries on its business through a PE in Australia. Further, those business profits will only be taxable in Australia to the extent they are attributable to that PE.
In the absence of a DTA, however, Australia is likely to have a broader reach in taxing Australian-sourced business income. This latter scenario may also result in double taxation.
There are exceptions specified in various DTAs of what will not amount to a PE. These typically include facilities merely used for display or delivery of goods, purchasing goods, preparatory activities such as scientific research or advertising or activities that are merely preparatory or ancillary in character. However, it is equally important to be aware of articles in Australia’s DTAs which deem an enterprise to have a PE where certain circumstances exist.
Ultimately, determining whether a physical presence in Australia amounts to a PE depends on the circumstances and is a question of fact and degree. It is therefore important to consider the nature and extent of your Australian operations, ideally prior to their commencement to avoid adverse or unexpected Australian taxation implications.
Establishing an Australian Company
Where you intend to establish a separate Australian legal entity, it is not uncommon to incorporate and conduct your operations through a company. This involves lodging incorporation documentation with Australia’s corporate regulator, the Australian Securities and Investments Commission, in accordance with Australian corporations legislation. Broadly, the two main forms of company are private and public, the former requiring at least one Australian resident director and the latter, two Australian resident directors.
A company will unequivocally be an Australian tax resident when it is incorporated in Australia. However, Australian income tax legislation also provides that a company that is not incorporated in Australia can also be a corporate tax resident where its voting power is controlled by Australian resident shareholders or its “central management and control” is in Australia.
Determining whether a company’s central management and control is in Australia is a question of fact and degree. Australian courts have considered that where a company’s directors reside in Australia and the board routinely holds its meetings in Australia and exercises independent judgment in its decision-making, the company will usually be an Australia tax resident.
Additionally, a company may be an Australian tax resident where the board consistently acts in accordance with the instructions or directions of a third party that is an Australian resident or where that third party dictates the affairs of the object company. The focus of the inquiry in this instance is where the company’s activities are controlled from rather than where its activities occur or the location of the company’s ultimate owner.
Once it has been established that a company is an Australian tax resident, its main taxation obligation is income tax which is generally payable at a 30% flat rate. However, a reduced corporate tax rate of 28.5% has recently been introduced for companies that are “small business entities” with an aggregated annual turnover below AUD 2 million. Such companies may also qualify for other small business taxation relief depending on their individual circumstances.
Corporate tax residents are required to lodge an annual income tax return to the Australian Taxation Office. Where employees are concerned, companies are also required to comply with the pay as you go (PAYG) withholding regime, make compulsory superannuation contributions on behalf of employees and pay various other federal and state-based taxes. Depending on annual turnover, a company may also be required to be registered for GST, Australia’s indirect broad-based consumption tax. These taxes have all been briefly considered in issues 2 and 3 of this series.
Another significant aspect of Australia’s corporate tax system is dividend imputation. To avoid double taxation, companies are able to “pay” a refundable tax credit (franking credit) referable to the amount of tax paid by a company when declaring and paying dividends to shareholders.
Whilst concessional tax treatment of dividends is not unique to Australia, there are various rules which need to be satisfied to enable shareholders to claim franking credit offsets; the primary requirement being that the recipient shareholder is an Australian tax resident. This is an important consideration when contemplating your share ownership structure. Withholding tax and profit repatriation issues also need to be considered.
As a separate (but no less important) matter, there are also numerous corporate law issues that overseas firms should be conscious of when establishing an Australian company. Company directors need to be conscious of the potential for personal liability in respect of outstanding PAYG withholding and superannuation guarantee payments. Depending on whether the company is a public company or has turnover, assets employees in excess of prescribed statutory thresholds, they can also be required to prepare a financial report in accordance with the applicable accounting standards and accompanying directors’ reports each financial year.
In addition, there are broad directors’ duties imposed on directors and sometimes officers and employees of a company to exercise their powers and duties in good faith and in the best interest of the company, to prevent trading while the company is insolvent and to keep books and records.
Ultimately, whilst companies enjoy separate legal entity status and perpetual succession and are ideal for raising future equity or transferring ownership, there are numerous taxation and corporations law compliance issues that warrant due attention when incorporating in Australia.
A final option to consider when tapping into the Australian market is the use of trusts. A trust is essentially a legal relationship recognised in common law jurisdictions (e.g. Australia, the UK and the U.S.) where a person or entity (trustee) holds capital and income for the benefit of others (beneficiaries).
Trusts can be complex from a legal and taxation point of view and given their jurisdictional heritage, are not generally recognised in civil law jurisdictions. However, the trust is a useful vehicle in risk management, limiting liability and conferring asset protection. In this regard, a trust can be a useful means of holding shares in an Australian registered company.
Additionally, trust structures can offer flexibility in making income and capital distributions to beneficiaries for Australian income tax purposes. This flexibility can facilitate effective tax planning but again, needs to be carefully considered.
Taking your next steps into the Australian market may appear to give rise to a myriad of legal and taxation considerations. However, it is important to get these compliance matters right from the outset to ensure you are investing in the growth and development of your Australian operations rather than incurring the cost if things go wrong.
Having familiarised yourself with these essential issues, the next question is how to finance your Australian-based operations. This and more will be considered in our next issue.