The Basics of Indirect Taxes and What to Consider Before an International Expansion
By Nick Hart, Senior Consultant, Indirect Taxes
To the optimistic business leader only taxes, not death, are inevitable. Accordingly, taxes are an important consideration when expanding overseas.
Nearly all countries charge some type of indirect tax on the local sale of goods or services. Understanding your company’s obligations and liabilities with regard to indirect taxation and devising effective tax compliance and mitigation strategies is an important ingredient in the success of an overseas endeavor.
About Indirect Taxes
For the purposes of this post, it is important to understand the basics of indirect taxes. Indirect taxes generally fall into one of two types: sales tax, which is familiar to most Americans, and value-added tax (“VAT,” also known as goods and services tax or “GST”), which might be unfamiliar. VAT is a form of consumption tax levied on a product or service on the value-added element applied at each stage of a supply chain through to the final sale to the end consumer. It differs from a single-stage sales tax in that it is charged in relation to each transaction within a supply chain. As with sales tax, the seller charges the buyer the VAT tax, which the buyer may then deduct from the value added when it in turns sells the good or service.
It is helpful, as well, to distinguish between the three most common entity types used in an expansion: representative offices, branch offices and subsidiaries. Because a representative office is an extension of the parent company without the ability to generate income, it does not in itself create an entity which will have any indirect tax registration obligations. Such obligations, however, may still exist for the parent company of the representative office. Branch offices and subsidiaries, by contrast, are entities capable of being obligated to register for local indirect taxes. In many jurisdictions, a branch may not be able to register for local indirect taxes in situations where a subsidiary would be able to register. This may be an important consideration for a company determining the optimal legal entity type when entering a new jurisdiction.
Key Questions to Consider Before Expanding
There are a host of important indirect-tax-related questions to answer before executing an expansion. The answers to the fundamental questions outlined below will necessarily vary between countries. It is, therefore, advisable to consult an expert on international indirect taxation systems before expanding into a new country. Without performing the necessary due diligence in this area, a company may ultimately face a variety of risks and additional costs, as well as exposure to action by local tax authorities.
- Is your entity required to register for the local indirect tax, and if so what are the compliance implications of this in terms of tax filings (e.g., filing frequency, deadlines and agent authorizations)?
- What are the operative taxes charged within the indirect tax system and at what rates? How are taxes collected, administered and remitted to the relevant tax authority?
- Is there an entitlement to be registered for the local indirect tax, and if so what are the benefits of doing so? (In some cases, your business may be able to recover taxes paid on operating costs or use a VAT registration to support your business’s legal/tax status in the country or region.)
- What are the operational implications of the indirect tax for your entity? Getting this wrong can cause your business to assume avoidable tax costs, commercial inefficiencies and third-party relationship issues. (Keep in mind that the relationship between the entity and the parent company can be important — for example, support services provided to the parent company by the local entity can be subject to taxation in some jurisdictions.)
- What tax optimization strategies can you employ to reduce tax liability or recover taxes paid? For example, can you shift the tax burden to vendors or other third parties through proactive contract structuring? What documentation is it advisable to retain to justify your approach to collecting and paying taxes?
These are only a few of the most important indirect taxation questions to consider when expanding abroad. It is also important to consider your company’s capabilities. Specifically, your tax compliance office, finance office and third-party management (among other departments) must be able to meet the challenges of expansion without disrupting existing operations.
In addition, it is important to be mindful of the variation in tax regimes. Even within the European Union, where there is a unified VAT framework, specific country rules regarding registration, recovery and compliance can vary greatly. A strategy that has worked in the past in one country may not work in a new country, even one with seemingly similar tax systems. That being said, indirect taxation should not prevent you from expanding successfully: With careful preparation, consultation and a conscientious approach to compliance, meeting your indirect taxation obligations will rapidly become business-as-usual.
For more information, watch our webinar recording Value Added Tax 101: Understanding the Basics.