When you are expanding from Australia into the U.S. you need to consider your objectives.  Are you entering the business to expand market share and build long term cash flow or are you expanding into the U.S. market as part of a high growth strategy pre-exit?

Selling a business that is operating in Australia and the U.S.

Entity Choice

The choice of entity in the US should reflect your intentions and objectives.  There is no “one size fits all” and establishing the right structure from the outset is imperative to ensure that you understand the compliance requirements and that the overarching business objectives are being achieved. When looking to enter the US market, the two most common entities choices are a Limited Liability Company (LLC) or a C-Corporation.

Corporations are similar in nature to Pty Ltd companies in Australia and LLCs to unit trusts. C-Corporations are independent businesses and are subject to corporate tax on profits. Taxes are also paid on the dividends paid to shareholders which can result in double taxation on the same income. In the international tax context where non-US shareholders are involved, it is important to consider the withholding tax on dividends paid to foreign shareholders and the availability of tax credits to foreign shareholding structure.

LLCs are treated as pass through entities, although the member or members are not liable for losses incurred by the business. Foreign members of LLCs are responsible to file a US tax return on income sourced in the US on an annual basis.

Each entity choice has its pros and cons which should be considered against the business objectives long term goals of the shareholders.

 

Australian Corporate Residency vs U.S. Corporate Residency

Understanding the corporate tax residency rules in Australia and the US is important for global families and founders to ensure that unintended consequences are not triggered with the tax authorities. The residency rules in Australia are substantially different to the rules in the US and failing to properly plan can often lead to costly tax and compliance issues.

In Australia there are three ways in which a company may be considered to be a resident of Australia for tax purposes:

  • where the company is incorporated in Australia; or
  • where the company is not incorporated in Australia:
  • the company carries on a business in Australia and has its central management and control in Australia (Central Management and Control Test); or
  • the company carries on a business in Australia and its voting power is controlled by shareholders who are residents of Australia (Voting Power Test).

It is important to understand how the authorities interpret whether central management and control is located in Australia. The legislation states that in order for a company to be considered an Australian tax resident, it must carry on business in Australia and have central management and control is in Australia. However, the Australian Tax Office (ATO) has recently taken a stricter interpretation of the rules in determining that a foreign incorporated company may be considered an Australian tax resident when central management and control is in Australia even if it does not conduct business in Australia. This new interpretation of the rules can have severe unintended consequences on global structures where directors and founders are located in Australia.

The US rules relating to corporate tax residency are far more straightforward. A corporation is considered a US tax resident if it is incorporated in the US. However, foreign businesses may be subject to tax in the US if they generate income that is effectively connected to a US trade or business or Fixed, Determinable, Annual and Periodic (FDAP).

U.S. Corporate Tax Rate Comparison Table

US and Australia corporate tax comparison
  Australia US AU-US Treaty Rate*
Corporate tax rate 27.5/30% 21% N/A
Withholding tax on dividends 0%/30% 30% 5%/15%
WHT on royalties 30% 30% 10%%
WHT on interest 0%/10% 0%/30% 10%
Non-Portfolio Dividend Exemption 0% 23.80% 0.00%
Branch Profits Tax 27.5/30% 30% US taxes the “dividend equivalent amount”; AU does not have a branch profits tax
Participation Exemption (sale of shares in Subsidiary) Non-assessable non-exempt income Dividend Received Deduction (DRD) Section 1248 generally provides that the gain on the sale of CFC stock is treated as a dividend to the extent of the undistributed and untaxed earnings of the CFC. Thus, upon the sale of a CFC, an exemption from gain would be available to the extent that the gain is treated as a dividend, as such dividends qualify for the exemption system described above.

Moving from Australia to the U.S.

If you are planning to relocate from Australia to the U.S. or spend a substantial amount of time in the U.S., it is important to consider the impact of your travel on your residency status. A change in residence can directly impact which jurisdiction has taxing rights over your income and assets and how your financial affairs should be reported with tax authorities and financial institutions.

The U.S. taxes U.S. Persons, as defined in the Internal Revenue Code 1986 (the Code), on a worldwide basis and non-residents on U.S. sourced income only. You are considered a U.S. Person if you are a citizen or ‘resident of the United States’. You are considered a resident of the U.S. if you are a green card holder, meet the requirements of the ‘substantial presence test’ (SPT), or elect to be taxed as a U.S. Person.

You will meet the requirements of the SPT if you spend more than 183 days in the U.S. in a calendar year or are deemed to have spent more than 183 days in the U.S. in a calendar year. For the SPT to apply, you must have spent at least 31 days in the U.S. in the current year and applying the following formula yield 183 or greater:

  1. Days in the U.S. in current year x 1; plus
  2. Days in the U.S. in year immediately preceding the current year x 1/3; plus
  3. Days in the U.S. in the year immediately preceding the year year referenced above.

 

Tax residency in Australia is a facts and circumstances based determination and can often be complex in circumstances where an individual is travelling extensively and has a global portfolio of assets. A taxpayer will be a ‘resident of Australia’[1] if one of the following tests applies to their circumstances:

  • they ‘reside’ within Australia in the ordinary meaning of the word reside (Primary Test);
  • if their ‘domicile’ is Australia (Domicile Test). A taxpayer will be domiciled in Australia if:
  • their father was born in Australia (domicile of origin);
  • they have chosen to reside permanently in Australia (domicile of choice); or
  • they are a dependent on a taxpayer who is domiciled in Australia (domicile of dependence), unless the Commissioner can be satisfied that their permanent place of abode is outside of Australia;
  • if they have actually been in Australia permanently or intermittently during more than one half of the year (Physical Presence Test), unless the Commissioner can be satisfied that the taxpayer’s usual place of abode is outside of Australia and the taxpayer does not intend to take up permanent residence in Australia; or
  • he is a member of an Australian government superannuation scheme (Super Test).

 

Investing from Australia to the U.S.

Structuring for passive investment in the U.S. requires an understanding of the U.S. and Australian tax residency rules, the circumstances in which profit will be characterized as income or capital gains in both countries, the U.S. withholding rates, the entity classification rules in the U.S., the foreign hybrid rules in Australia, and whether income tax paid in the U.S. will be creditable in Australia.

It also requires an understanding of the U.S. Estate Tax rules and whether the nature of the investment if owned directly in indirectly through a foreign structure will be subject to U.S. Estate Tax.

For family offices and private businesses, it is important to understand the comparative economic difference between investment structures and how to ensure you optimize your after tax returns.

 

Selling a business that is operating in Australia and the U.S.

The structure of U.S. Australia deals will be dependent on whether the acquirer is looking to buy the the entire business or the U.S. business only and where the acquirer is based.

If the acquirer is based in the U.S. they may not have a desire to operate the business through an Australian holding company or operating company structure.  In our experience it will be the business objectives of the acquirer that will dictate the legal and economic structure of the deal.

 

It is important that you are aware of the following U.S. tax issues that will reduce the value of a business in a U.S. Australia deal:

  1. Non compliance with income tax information reporting;
  2. Non compliance with transfer pricing documentation and U.S. withholding tax;
  3. Non compliance with sales tax filings;
  4. Non compliance with state income tax filings; and
  5. Incorrectly characterizing employees as contractors. This can result in a failure to withhold and collect payroll tax.

[1] Section 6-1 Income Tax Assessment Act 1936 (Cth).


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