Peter Harper‘s second installment on the popular podcast, TaxTalks discusses what you need to know when expanding into the US. The United States can seem like a complicated market for ventures, but with proper planning and high-level strategy, it can be manageable.
Listen to the last episode here and tune in soon for the third and final episode of this series.
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Peter Harper: When you work through all this stuff, you realize there’s really a limited number of choices that operators have. When you break down the economic outcomes, there’s really a limited number of options.
Announcer: You’re listening to Australia’s podcast for Accountants: Tax Talks, the podcast to grow your firm.
Heide Robson: Welcome to Episode 356 of Tax Talks. This is Heide Robson, and thank you to Class for sponsoring this episode. When your clients want to expand into the US and ask you how to structure this, what do you tell them? This is the question to Peter Harper of Asena Advisors in New York, California, and Florida. Peter will talk about Australia-US cross-border business structures, and also, briefly, branch profit tax. Before we start, a legal disclaimer.
Peter Harper: So (before) we talk about these complex questions, I want to caution listeners that each case that may come before them will be unique and it is vital that they consult with someone that has US expertise in order to handle delicate matters. These topics are not simplistic and need experience and proficiency to tackle, so please reach out to us to address any issues that your clients may bring up with the diligence they deserve.
Heide Robson: So now to Peter Harper of Asena Advisors. The first question to Peter is what are the most common scenarios among Australian businesses expanding into the US?
Peter Harper: I think there’s really a big transition, and when I’m starting this process and talking to a prospective client about this, I’m asking really what is your objective? Are you an Australian business that’s just using the US for distribution of a particular product? You know, when you think about the Internet age and you think about e-commerce businesses, you can sell stuff anywhere. And really the way I think about it is I say, is the US just another distribution channel for you, or are you building a business that requires a real physical footprint in the US? And if you look across the framework of a lot of different businesses we’ve had advised, they really kind of normally fit into three buckets:
Peter Harper: One, you’ve got an e-commerce, a typical e-commerce business where it might be headquartered out of Australia, products being made in Asia, and then effectively drop-shipping it into the US. You’ve got a software business where, again, everything’s Australian grown; they’ve got some form of (a) subscription-based platform where US-based customers are just signing up via a website or some derivation of that. And then the third is where you’ve got the type of business that is going to be people-heavy and requires physical boots on the ground to do it. So in the context of the third business where you’re expecting to have physical people on the ground, then it’s going to be the case that, very quickly, you have a US trade or business payment establishment, and to the extent, (while) you’re generating locally sourced income, you’re going to have effectively connected income.
Peter Harper: With respect to the two forms of businesses, there’s flexibility around that. There was a further question that you had asked me around how does this concept of US trade or business versus permanent establishment differentiate? And so for those who aren’t familiar, US trade or business is the US domestic legal concept or threshold that needs to be satisfied. You know, one part that needs to be satisfied (is) to have US-sourced income, the other is effectively connected income, and the treaty language is this concept of permanent establishment. So the US domestic concept is, in my opinion, actually a lower threshold; (it’s) something that’s easier to satisfy than the treaty threshold.
Peter Harper: The US concept of a US trade or business is actually a lower threshold than the treaty threshold. So the treaty threshold is whether you’ve got a permanent establishment and whether you have income under Article Seven that’s business profits connected with a permanent establishment. And given that in the context of the US and Australia, there is a treaty.
Peter Harper: While it’s relevant, normally you have to have a US trade or business because we do have a treaty. In most cases, we are always going to be focused around, okay, well what is the treaty application to this particular factor? So when I’m thinking through my client’s facts, I’m saying, what is it about your planned expansion plan that’s going to create a permanent establishment?
Heide Robson: So even though the US trade or business threshold is lower, and hence that would be a bad thing because it means you trigger a US TB much easier. Even though it’s a lower threshold, when you have a treaty as Australia does, you actually focus on the PE definition and not on the US TB definition.
Peter Harper: Yeah, because the treaty will override it to the extent that it’s relevant, which in this particular instance it would. So when you actually look at the treaty definition of “permanent establishment”, it’s extremely rigid, right? You got to have a fixed place of work, warehouse… You know, it’s very industrial built for an industrial age. So the question that we’re always asked is if you’re doing an e-commerce business and you drop shipping from some three PL warehouse, it’s not your warehouse, someone else holds your product. That’s not going to create a permanent establishment. So even if you’ve got US-sourced income, if you’re generating effectively in connected income, if you don’t have a permanent establishment under the treaty, you’re not going to have US taxable income.
Heide Robson: So coming back to the three main scenarios you see, which is a product business expanding their distribution into the US, or a software business based in Australia expanding their subscriptions into the US, or third, an Australian business actually building a business in the US for the US footprint. When you look at these three scenarios, the first one we see (is the) e-commerce product business expanding their distribution into the US. I assume the two main options are either to just try it through your Australian entity or to set up an LLC. And then you most likely don’t have ECI in the US and hence that income is not taxable in the US, so you would only tax it in Australia?
Peter Harper: That’s right. It’s great that we’ve spent so much time talking through this notion of the LLC not having a permanent establishment, right, because that is the case. Most of our clients that are looking to make real footprints in the US, or more often than not, will operate and set up their businesses through C corporations, not through LLCs. In the business context, the only times when we see folks actually coordinate and set up in the US will be if they’re running an e-commerce business and they don’t expect they’re going to have a permanent establishment, right, so there’s no nexus to tax income tax. Or if there’s going to be one Australian partner in a US business and one American partner in a US business.
Heide Robson: But if there is no US partner, if it’s entirely from Australia, then the first scenario will most likely run through an LLC, and the second scenario will most likely run through an LLC again. But my question is, is that correct, or is there also an argument to just do those too, just through your Australian entity? When would an Australian entity running either an e-commerce business or a software subscription business, when would they change from just trading through their Australian entity to an LLC?
Peter Harper: Well, with a software business, it’s slightly different in the sense that even though they might have people, you know, engaging through a platform and signing up and paying subscriptions into an Australian entity so you don’t have this US footprint for an Australian entity that’s selling, most of them need to have substantial teams physically present in the US to do various tasks, right? So the one major difference is in software businesses, there’s far more significant segregation of roles. So there might be a US subsidiary that’s established to employ staff that might be doing forward-facing marketing-sales work on behalf of the business. So cost management components, and then all the revenue generation is still happening through the Australian company.
Heide Robson: So the software business might have people on the ground in the US, but they would then run that through a separate C-corp, and then the revenue-generating would still be running through an LLC flowing to Australia.
Peter Harper: Correct. The only real time we see LLCs used in operational businesses is if they’re being utilized by e-commerce businesses that don’t have a physical footprint in the US.
Heide Robson: And why would an e-commerce business, for example, change to an LLC and not just trade from Australia through their Australian entity?
Peter Harper: The core reason’s banking. They’re not going to get banking relationships set up in the US with US institutions. So they can have US-based payment and processing and all that type of stuff can be US-based, and that’s not going to create taxable nexus. But that stuff can be critical to setting up APIs with Shopify and various other payment gateways.
Heide Robson: So for an e-commerce business, the main reason to change to an LLC is usually banking or insurance.
Peter Harper: Correct.
Heide Robson: And then for (a) software business, the main reason to change to an LLC is probably the same. And then it’s also banking or insurance and/or insurance, and then they might need a C-corp on the side if they also employ staff.
Heide Robson: Quick question (on) branch profit techs: because I was expecting you to say at some stage that branch profit tax is an issue, can you tell me more about branch profit tax? Does it play a big role in your structuring advice?
Peter Harper: Not really. And the reason for that is most businesses of a certain size in Australia are structured through companies, and so branch profits tax applies if you have a foreign corporation that is (the) sole owner of a US LLC because technically that’s a branch for US tax purposes, and it also applies to a US branch of a foreign corporation. And the tax treatment for that scenario, for an Australian company owning a US LLC, when it comes to branch profits tax, it’s identical to the tax outcome of an Australian company owning a US C-corp. And when I say identical, this is what I mean: technically, with branch profits tax, you’ve got this rate of tax that’s an additional 30% above the corporate tax rate. That rate of tax is reduced to 5%.
Peter Harper: And so, just remembering with the branch, what we’re effectively saying (is that) income that’s generated by a foreign corporation in America is flowing out of America theoretically, even if it’s still sitting in a bank account. This is how the tax rules treat it; they treat it like it’s been repatriated to the foreign country. And so you have the US corporate tax rate, then you have another 5% on top of that. If you take a US C corporation that pays a dividend back to an Australian holding company, it’s the same outcome. You have the US corporate tax rate, then you have the dividend withholding tax rate (getting) reduced from 30 down to 5% because you’ve got more than 10% owned by foreign companies.
Heide Robson: If the proprietary limited owns 100% of the C-corp, withholding tax is zero, correct? Because they own more than 80%?
Peter Harper: No, no. That’s only the case with public companies.
Heide Robson: Ah, I see.
Peter Harper: Yeah.
Heide Robson: Okay. So a private company would still have a 5% withholding tax?
Peter Harper: Yeah, correct.
Heide Robson: Okay. And hence, the branch profit tax is also 5%.
Peter Harper: When you think about it in that logical way where we say, okay, the branch profits tax, the objective of the tax policy is to ensure that branch profits are taxed identically to dividends, you go, “Okay. Well, that makes sense.” So then the flow on from that is why would you ever set up an Australian company as the sole owner of a US LLC? Right, because the tax outcome is going to be the same, and what you’re actually doing is you’re now requiring your Australian company to file a US tax return. And, for a whole bunch of different compliance reasons, in my opinion, I think it just doesn’t make any sense.
Peter Harper: So again, what that really results in is, going back to my initial statement of why are you doing this, are you doing this to build cash flow? Are you building this future capital value? When you work through all this stuff, you realize there’s really a limited number of choices that operators have. When you break down the economic outcomes, there’s really a limited number of options.
Heide Robson: So never have an Australian propriety limited holding an LLC alone. If you have a proprietary limited holding an LLC, you need somebody else in there so that it becomes a multi-member LLC, because then the branch profit tax doesn’t apply anymore. Correct?
Peter Harper: Yep.
Heide Robson: Okay. So the branch profit tax only applies if an Australian propriety limited holds an LLC as a sole member. And it also doesn’t apply if an individual holds an LLC alone, correct? Or does it apply?
Peter Harper: No, it doesn’t apply to an individual holder directly. Yeah.
Heide Robson: For an e-commerce, you most likely do an LLC. For a software business subscription, you most likely do an LLC for banking and insurance purposes. And then for a business with a footprint in the US, (you’re) most likely structured through a C-corp, correct?
Peter Harper: Correct.
Heide Robson: Welcome back. So branch brand tax only applies to non-US corporations, and only if that corporation either operates directly in the US or through a single member LLC. So if an Australian entity is an individual partnership or trust, no branch profit tax. And if the Australian company operates through a multi-member LLC, no branch profit tax either.
Heide Robson: So an Australian company only faces branch profit tax if it either operates directly in the US or through a single member LLC, and, of course, has effectively connected income to a US trade or business. And the point of the branch profits is to mirror the taxation of a foreign head C-corp. When you hold a C-corp in the US, the withholding tax is 30% without a treaty, and the US Australian DTA then reduces the withholding tax to 15%; or, if you hold 10% or more, to 5%. And so exactly the same happens for branch profit tax: the branch profit tax is 30%, but the US Australian DTA then reduces it to 5% because, of course, naturally you hold 100% of a branch, so the lower 5% applies.
Heide Robson: The difference between the two is that the branch profit tax is a lot more complicated to calculate. To calculate, you take the earnings and profits for the year effectively connected to a US trade or business, but then deduct any amounts reinvested into branch assets. So the taxable base for the branch profits increases or decreases by any decrease or increase in the US net equity of the branch.
Heide Robson: So this reminds me a bit of the distributable surplus for divisions of net purposes where you also look at the balance sheet to determine the tax base. And then also, as if this was not already confusing enough, the branch profit tax also applies when the tax deduction claimed for interest by the branch on its US tax return exceeds the amount of interest actually paid during the year. So that can get complicated, and we touch on this in the next episode as well. But before we come to the next episode, let me just quickly play you a clip about what Peter’s firm does, Asena Advisors, and then also the Asena family office.
Peter Harper: Asena Advisors is part of our broader, integrated multifamily office ecosystem called the Asena Family Office. As a whole, we provide a wide range of services from a unique problem-solving perspective. Our companies provide specialist in-house deal support to private clients that are focused on post-transactional liquidity and holistic private wealth solutions that enable them to capture future upside while rebalancing risk for the next generation. We also operate global tax desks in the area of US, Australia, and US India taxation, and these desks serve to provide services that don’t just focus on tax, but on the client as a whole.
Heide Robson: In the next episode, Episode 357, Peter Harper will go through a number of questions with you; notably, whether you should send debt or equity to your new operations in the US. So that is for next week. Until then, thank you for listening, and thank you to Class for their support. Bye for now and see you in the next episode.