Venturing abroad allows your company to benefit from new markets, diverse revenue streams, and a wider hiring pool. However, it also carries the risk of double taxation, which can cut into your budget for global expansion.
Although tax treaties may reduce the financial burden on your organization, they’re not a simple solution. Most countries still expect foreign businesses to abide by strict laws and regulations. That means HR teams must navigate many complex and ever-changing rules to avoid penalties and legal action.
This article explores how you can address common financial and compliance challenges and use Deel’s solutions to mitigate the risk of double taxation greatly.
Mitigating international double taxation
As the name suggests, double taxation happens when you owe tax to multiple jurisdictions. Businesses typically encounter this problem if they earn taxable income or own assets in a foreign country.
For example, imagine your head office is in the US, but your subsidiary in Cambodia generates $100 thousand (USD) per year. You would owe 20% for the foreign income plus the American corporate tax rate of 21% — leaving you with a $41,000 bill.
With such high costs, you probably wouldn’t decide to expand abroad. That’s why many governments have introduced tax reforms like treaties to reduce the financial burden on multinational businesses and encourage international trade.
Tax treaties are contracts between countries that dictate how multinational companies operating within both countries’ borders will pay taxes. While the terms of each treaty can vary depending on the countries involved, they generally adhere to guidelines established by the Organization for Economic Cooperation and Development (OECD).
You can prevent double taxation by investigating the tax treaties of the countries where you want to invest. However, researching these agreements may be time-intensive. Most countries have dozens of treaties that they update continuously, especially major trading nations like Germany and the UK. In fact, the US has over 60 treaties with other countries.
Specialized local tax advisors can perform this extra work, which is always indicated to foster healthy business growth.
Hire anywhere without worrying about local laws, complex tax systems, or managing international payroll. Focus on finding the perfect match for your team, we’ll take care of the rest.
Overcoming compliance challenges
While tax treaties benefit global enterprises, they’re not a straightforward solution. Businesses must stay updated and comply with each agreement’s tax rules.
The issue is that some multinational corporations leverage treaties solely for tax purposes. They might exploit loopholes in agreements or artificially move profits to countries with lower tax rates. The OECD calls this problem ‘base erosion and profit shifting’ (BEPS) and estimates it costs governments $100 to $240 billion annually.
Policymakers have started taking steps to prevent tax treaty abuse, such as enforcing stricter conditions, monitoring economic activities, and even taking legal action. For example, France recently fined Google $500 million for tax avoidance.
Even if businesses win their cases, compliance issues can damage reputations and lose customers’ trust. So, while Starbucks won a dispute about its subsidiaries in the Netherlands, the case has been the source of much bad press.
On a smaller level, there’s also the risk of noncompliance by withholding taxes or filing tax returns incorrectly. Authorities often charge you a percentage of the tax owed plus interest for these violations.
Setting up fair but compliant transfer pricing
Aside from paying the correct tax, multinational companies must also set reasonable prices for transactions between all their subsidiaries. They may face tax avoidance claims if rates are too high or too low.
You may think of the exchange of goods between different branches. However, transfer pricing also applies to:
- Inventory allocation
- Operating expenses
- Management and marketing fees
- Insurance and benefits
- Salaries, profits, and dividends
Organizations might strategically transfer these funds and assets based on which countries have the lowest tax revenues. For instance, the European Commission alleges that Apple only set up subsidiaries in Ireland to avoid paying US tax. It claims Apple artificially raised transfer prices on Irish licenses to shift its profits abroad.
Many governments have tax policies about setting adequate transfer prices to prevent this kind of tax avoidance. One common rule is the ‘Arm’s Length Principle,’ which states that corporations must set transfer prices equivalent to the exchange rate between unrelated parties.
In trying to abide by these laws, your company may set excessive transfer prices and affect their profitability.
To establish fair prices, engage tax experts to help you draft policies that comply with the Arm’s Length Principle. There are a few popular methods for doing this:
- Comparable Uncontrolled Price (CUP): Match the price of equivalent transfers on the market
- Cost plus method: Add a fixed amount of percentage to the cost of the original product or service
- Profit split method: Divide the outcome of a venture according to each branch’s contribution
Managing complex cross-border transactions
Engaging in cross-border transactions requires an extensive knowledge of foreign tax systems. Otherwise, you may inadvertently trigger double taxation or violate regulations, both of which incur high costs.
The issue is similar to setting transfer prices. Global enterprises usually move funds and assets to different countries during cross-border transactions. For example, they might acquire a foreign company and transfer equipment to its premises.
However, many companies use transfers to shift profits and avoid paying high rates. They might use foreign acquisitions like the one from the example above as a front for tax avoidance schemes.
As a result, countries have become increasingly stricter about regulating cross-border transactions. They often introduce General Anti-Avoidance Rules (GAARs), which allow them to deny tax benefits to companies on a case-by-case basis. That means if a global enterprise has found a new way to shift corporate profits, governments can still penalize them.
Navigating this maze of ever-changing laws and regulations to avoid charges can be challenging. HR teams must familiarize themselves with international guidelines and predict what could count as a GAAR violation.
Moreover, transferring funds or assets abroad also leaves you at risk of permanent establishment (PE). This is when a government believes you have a significant presence within the country and charges you extra taxes and fees.
To mitigate the risks, conduct thorough due diligence and assess the tax implications of any transactions. Here are some steps you might take to stay compliant and ensure the success of your venture:
- Gather financial data: Ensure you can prove the venture is a sound investment in case the government questions your business motives.
- Review the contract: Check any legal obligations that won’t leave you vulnerable to tax and legal issues.
- Seek an advanced tax ruling: If possible, clarify your arrangement with the relevant tax authorities before you enforce it.
- Compare tax treaties: Identify your tax obligations, including any indirect taxes and any benefits you may be eligible for.
Streamline data management and reporting
Having the right data is essential for effective tax reporting and compliance management. You need this information for everything from justifying transfers and filing taxes correctly to claiming deductions.
Inaccurate or delayed reports can lead to penalties. For example, the Internal Revenue Service (IRS) charges 5% of the total amount due for each month you fail to report your income tax.
However, collecting data can be resource-intensive, especially when your company operates across multiple jurisdictions. That’s even more true when HR teams have to collect and analyze data from countries with very distinct tax systems. They may have to familiarize themselves with disparate tax codes, rates, and even number formats.
Prioritize effective international tax management
Navigating international laws may help you avoid penalties, but tax planning is what will allow your business to grow. By managing finances effectively, you can keep costs low and increase your budget for expansion.
Proactive tax planning can help you identify areas where you can save costs. Here’s a list of potential opportunities to look out for:
- Foreign tax credits: According to the IRS, for example, businesses can get a deduction for income subject to both US and foreign taxes
- Interest expense deductions: You can sometimes claim back expenses from international expansion
- Repatriation deductions: If your subsidiaries have to make payments to your company’s tax base, you may be able to offset some of the costs
- Local tax incentives: Some markets encourage foreign investors with preferential duties and credits
There’s a large number of tax benefits, and they change constantly. To ensure you don’t miss opportunities, continuously review your tax strategy and all international branches. Taking an agile approach also enables you to adapt to your changing business needs.
Make the most of international tax benefits with Deel
Expanding your company abroad promises exciting opportunities. While double taxation poses a significant risk, there’s no need to let it hinder your growth.
Deel helps companies comply with workers’ rights in each country and handles taxes strictly according to local regulations. When companies use Deel, they pass on the taxes Deel bears in each country, which greatly mitigates double taxation risks when hiring employees.
Companies can consult local lawyers and accountants whom Deel can recommend for any other type of international tax advice.
