Online shopping is growing, figures show. If you run an online business and have been thinking about expanding your operations globally, you need to consider possible offshore tax ramifications.
With online shopping becoming the norm and promising strong growth and opportunities, it is not surprising that a number of Australian-based businesses have taken steps to sell their goods beyond our shores.
Ordinarily, making an online sale to a non-resident has few offshore income tax ramifications until the Australian business has a presence in the offshore jurisdiction (by way of some combination of personnel, equipment and premises). A recent development in online sales has been the establishment of distribution centres by Australian businesses in foreign countries. Such distribution centres allow Australian businesses to present themselves as domestic businesses in the foreign jurisdiction while significantly reducing delivery times to customers, both important factors in a competitive market. Once a distribution centre has been established, the Australian business will generally need to consider whether the source of any of its income is in the foreign jurisdiction, and if so, whether that foreign sourced income is shielded from income tax in that foreign jurisdiction by operation of a double tax agreement (DTA).
This article considers the potential application of foreign income tax to Australian online businesses that sell to foreign countries, where the Australian business has a distribution centre in that country, and where Australia has a DTA with that country. This article will refer to the Australia-UK DTA for illustrative purposes. Although a similar outcome can be expected under other DTAs that are based on the Organisation for Economic Co-operation and Development (OECD) model, it is important that each DTA be examined to accommodate the various nuances of individual DTAs. This article will also briefly consider other relevant tax considerations in undertaking international operations.
Will a distribution centre create a taxable presence in a DTA country?
Under the Australia-UK DTA, the UK cannot tax the business profits of an Australian resident enterprise unless that enterprise derives those profits from a permanent establishment located in the UK.
Subject to certain exceptions, a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term “place of business” used in the DTA in this context covers any premises, facilities or installation used for carrying on the business of the enterprise. It doesn’t matter whether any such place of business is owned, rented or otherwise at the disposal of the enterprise. A place of business will be “fixed” if it is located at a specific geographical point for a substantial period of time. What constitutes a substantial period of time depends on the facts and circumstances, though six months is generally a helpful benchmark.
The warehouse from which an Australian enterprise’s distribution centre will operate from in the UK is a clear example of a fixed place of business. However, a fixed place of business will not be a permanent establishment if the activities carried on from that fixed place of business are merely preparatory or auxiliary in nature. Specifically, under the DTA, an enterprise shall not be deemed to have a permanent establishment merely by reason of:
- the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or delivery;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
- the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or collecting information, for the enterprise; or
- the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.
Having regard to the above, it is potentially arguable that the activities of an Australian business at a distribution centre should be solely for the purpose of storage, display and/or delivery of goods or merchandise belonging to the business, depending on all the facts and circumstances. For this argument to hold true, the Australian business will need to exercise care and continually review the activities of the distribution centre to ensure that its activities do not extend beyond storage, display and/or delivery of goods. Some examples:
- All sales activity will need to be performed outside the UK. UK staff must not participate in decisions related to the type, quality or quantity of products sold in the UK.
- All import activity should be limited to simple processing – UK staff should not be involved in negotiating purchase contracts in any way.
- UK staff must not perform any management activities that do not relate to the importation, storage and delivery of goods.
- The internet-based accounts used for sales will need to be administered outside the UK.
- No after-sales support should be provided by UK staff.
- All design and manufacturing activity should be performed outside the UK.
- Payments should be processed outside the UK.
What are the consequences of the distribution centre creating a taxable presence in a DTA country?
If the activities of the distribution centre extend beyond storage, display and delivery of goods and a permanent establishment arises, its business profits can be taxed by the UK. The amount of taxable income attributed to the permanent establishment will be determined with regard to the functions and risks undertaken and the assets held by the permanent establishment. This means that only part of the total profits from an online sale may be taxable in the UK because the distribution centre is not responsible for all the activities that give rise to that profit. A detailed analysis will be required to support the attribution of profits.
If the permanent establishment is controlled by an Australian company, any profits of the UK permanent establishment will be non-assessable non-exempt income for Australian income tax purposes by way of the foreign branch profits exemption under the Australian tax law. Consequently, the profits of the permanent establishment will not be taxable in Australia, and no foreign income tax offset will be available for the UK tax payable. In any other case, the Australian taxpayer will be assessed on the UK profit and may be entitled to a foreign income tax offset against its Australian tax liability for any foreign tax paid on an amount included in its assessable income.
Once an Australian business has a taxable presence in a DTA country it may be a better option to incorporate a subsidiary in that country. This makes dealings in the UK easier and allows for intercompany loan and management agreements to be put in place between the Australian business and the UK business, where appropriate.
Other matters to consider when expanding an online business overseas
Once an Australian online business establishes a distribution centre in a foreign country, its compliance obligations in that country will need to be closely monitored beyond concerns about income tax. For example, the Australian business may need to:
- register a branch with the relevant domestic statutory authority if it is taken to be carrying on a business in the foreign country;
- appoint a local agent/public officer for taxation and corporate regulation purposes;
- determine whether the branch is required to lodge financial statements with the relevant domestic statutory authority;
- apply for business identifiers such as the equivalent of the Australian Business Number (ABN);
- register for a consumptions tax such as GST/VAT;
- determine its customs duty obligations; and/or
- comply with all employment tax obligations such as salary withholding and pension schemes.
As has been demonstrated, the offshore taxation treatment of an online business operating in a foreign country is dependent on a number of factors. The shelter provided by a DTA may not always be available, in which case an Australian business must be aware of the reach of the relevant foreign country’s tax and corporations law, and will often need to tackle the issue of source in respect of its assessable income. Where a DTA is available, care will need to be taken to identify the extent of the distribution centre’s activities, and to monitor any changes to those activities in future to determine whether a permanent establishment exists. Once a permanent establishment arises, the Australian business will then need to address its tax liability in the foreign country and consider whether to incorporate a subsidiary in the foreign country. In any case a local adviser will need to be consulted, record-keeping will be very important and regular compliance will need to be addressed.