“The Asian tax world is flat, with every country out for its fair share of the tax revenue.”Chee Weng Lee,
Asia-Pacific Tax Markets Leader,
Ernst & Young
The commercial structure you establish in Asia today can have a myriad of tax and financial consequences years into the future. As authorities in Asian countries become more sophisticated at both attracting foreign entrants and extracting taxes from them, an understanding of the financial and tax considerations executives should be aware of when considering different operating structures becomes critical.
Structuring a business starts with the premise ‘form follows function’, whether that function is setting up manufacturing and distribution, establishing a talent hub or accessing a customer base. But as Trevor Hughes, Asia-Pacific Business Tax Services Leader, Ernst & Young, points out, the financial perspective — particularly tax costs — also needs to be front of mind when deciding on your structure.
He says executive teams need to consider the tax costs of:
- Establishing the structure
- Building and running the business — including corporate and indirect taxes
- Introducing more capital
- Moving into a joint venture
- Repatriating profits and exiting the business
Understanding those costs can be very challenging, given that regulations and tax practices differ hugely from country to country. And not just in terms of the actual legislation.
“In many countries you can’t depend on the black and white operation of the law. For example, in terms of tax treatment of expats, we often see practices that clearly don’t align with the official treaty. So, if you want to do business in that country, you have to understand the practice (not just the law) before you can decide whether it really makes sense to locate your expatriates in that jurisdiction.”
Chee Weng Lee, Asia-Pacific Tax Markets Leader, Ernst & Young, agrees: “Tax law enforcement can vary across China depending on local interpretation and application of each statute. Often we find different applications from province to province. It’s no good having an agreement with the State Administration of Tax (SAT); you also need to get the Tax officials in the provinces on board. You can’t just say to a regional tax official: ‘I will communicate directly with the SAT in Beijing’. That’s not how business gets done here.”
He warns Australian companies not to mistake transparency issues for sophistication issues.
“The Asian tax world is flat, with every country out for its fair share of the tax revenue. Many governments are increasing taxes, stepping up tax enforcement and working much more closely together. They are sharing information on tax planning to get rid of any tax arbitrage or abuses.”
The tax officials in some Asian countries are well connected with the Australian Taxation Office (ATO).
“Throughout Asia, the tax authorities have never been so focused on collecting their fair share of tax as today. We’re seeing an increased focus on transfer pricing, tax controversy, challenge on indirect transfers and indirect taxes as a means of enhancing tax revenue.”
This changing environment presents considerable challenges for Australian entrants.
“Companies not only have to be aware of changes in policy in any of the jurisdictions in which they operate, but actually anticipate increased enforcement and challenges to their position so their investors, board members, and audit committees are not surprised by any significant potential controversies or litigation.”
And high profile tax controversies are certainly on the rise in the region.
“In November last year, an Indian court ruled a major telecom company must pay capital gains tax on the acquisition of an Indian subsidiary of another Hong Kong based telecom company, even though the deal was conducted between offshore subsidiaries. The case has now been passed to the Supreme Court, but if it loses, the company could be liable for up to USD2.5bn in taxes.”
He believes cases like this are less about governments trying to raise revenue from taxes, and more about shaping the behaviour of global investors and cross-border acquirers. He expects China to jump on the same band wagon.
“This is yet another indication of government being ‘in the game’ and being willing to pull new levers as part of their industrial policy. It all points to a future where tax audits will continue to pick up and governments will become increasingly sophisticated in their approach to tax. Already, holding company structures, back-to-back financing and royalty arrangements are under increasing scrutiny.”
Australian entrants need to take extreme care in the way they structure and document transactions.
“This isn’t just about financial risk — your reputation is also on the line. For the first time in many years, Asian tax authorities will publish investigations in the media or on the authority’s web site. Even if you are cleared, you can’t get rid of the question mark over your name,” warns Lee.
Trevor Hughes says this increase in tax competition between Asian governments and the aggressive tactics of some authorities mean that organisations need to take a more sophisticated approach to structuring.
“You need to involve the tax function in the structuring decision-making process — ideally from the outset. Don’t move until you have a clear plan for managing your tax compliance and your statutory accounts reporting obligations across a number of jurisdictions. Typically, we find supporting these responsibilities requires sophisticated technology platforms and support, either in house or external.”
He points out that it’s not all bad news.
“This continuing focus on tax competition has the potential to create significant advantages for companies seeking to invest in Asia.”
But, the key is to understand the subtleties of the tax landscape.
“What we’re seeing is a vastly different decision-making process from what it was even five and certainly ten years ago. If you’re going to be working across multiple Asian jurisdictions and into and out of Australia, then understanding the matrix of financial and tax decisions, as well as the broader business decisions in that matrix is very important.”
Claus Jensen, Oceania Supply Chain Leader, Ernst & Young adds: “For example, there are trade offs in your supply chain design and strategy that should be considered: proximity to suppliers and stock and supplies, versus “control” close to the customer.