To succeed in a global economy, strategic international tax planning is needed. Companies that do not practice strategic international tax planning would suffer a major competitive disadvantage in the global marketplace. When a competitor enters a market with a higher tax rate, they must sell higher-priced goods with lower income. Companies that are unfamiliar with international tax laws, cross-border transfer pricing conditions, and double tax treaties are far more likely to incur excessive foreign tax costs and penalties.
Companies that participate in proactive multinational tax planning have a significant competitive advantage. A competitor who enters a market with a lower tax burden will sell goods at a lower cost and make more money. To mitigate tax burdens such as high international corporate tax rates, customs, and duty costs, and high withholding taxes, careful cross-border tax planning is required. Businesses should consider taxes as a regular expense that can reduce their bottom line income.
What Is Tax Planning?
The analysis of a financial situation or strategy to ensure that all factors work together to enable you to pay the least amount of taxes possible is known as tax planning. A tax-efficient plan is one that reduces the amount of money you spend on taxes. To reduce the group’s tax burden, international businesses employ a number of tax planning techniques, some of which are briefly discussed below:
# 1. Income Shifting Strategies
Transfer pricing of goods and intangibles is a tax planning technique in which profits from high-tax countries are transferred to low-tax countries. It could result in a significant reduction in tax revenue for the high-tax nation. Moving the amount of tax collected to future years, on the other hand, reduces current tax payable. The price for the transfer of goods or intangibles is generally supported by a study, to make sure transfer pricing is reasonable to industry standards.
#2: Offshoring Tax Strategies
The growing trend of businesses outsourcing many aspects of their operations to various foreign-based companies has opened up a slew of new tax planning opportunities. If you live in a high-tax jurisdiction, you will owe a lot of money in taxes, particularly if you own a business. If your company conducts all of its operations in a foreign country and you have no physical presence or local transactions in the country where you live, you could be paying more taxes than required. If your company or investment is based in a no-tax jurisdiction, you must ensure that your corporate structure complies with the company tax laws in your home country.
#3. Use of Tax Havens:
Many people have adopted a policy of relocating to countries that offer lucrative tax advantage options after identifying the right opportunities.
This is becoming increasingly possible as people’s lifestyles become more mobile, particularly because most high-tax countries only tax you if you remain a resident within their borders. The United States is an exception since it taxes its people regardless of where they live.
Around 40 tax havens exist around the world. They are typically small, wealthy countries (often islands) with sparse populations, limited natural resources, and well-developed communication networks. The OECD released a list of tax havens and urged them to strengthen their information exchange with other countries because tax havens minimize tax revenues in high-tax countries.
# 4. Tax Deferral:
It is a tax planning tactic in which an international business’ subsidiary does not repatriate the parent company’s earnings (dividend, or interest). As a result, the parent corporation pays no taxes in its home country, and the affiliate pays no withholding taxes in its home country.
# 5. Regulatory Arbitrage:
This is a tax planning technique that takes advantage of regulatory gaps between countries. There is room for tax reduction if two countries handle an overseas branch differently, resulting in a disparity in tax status. The Corporation may create a branch outside of its home country that is taxed as an offshore unincorporated ‘branch’ in its home country but is treated as an offshore incorporated entity in the host country.
Similarly, if two countries disagree on the tax status of hybrid securities, the Corporation can issue hybrid financial instruments (with both equity and debt features) that the affiliate purchases. The hybrid instruments are regarded as equity by the foreign business’ parent country’s tax authorities, but as debt instruments by the affiliate’s tax authorities.
# 6. International Holding Company:
An autonomous subsidiary or regional headquarters is referred to as a holding company. A tax planning strategy is to create a foreign holding company. It is founded in a low-tax jurisdiction and can save a multinational business millions of dollars in taxes. A holding firm that has no operational operations or profits is known as a ‘pure’ holding company. Its primary goal is to maintain a “long-term stake” in one or more independent businesses. A Euro-holding company is a holding company formed in the EU by a US parent company that communicates with the US parent company’s EU subsidiaries.
# 7. Corporate Inversion:
It’s a tax-planning tactic that involves the transfer of corporate identities. The organizational structure is reversed, with the parent corporation being the subsidiary and the subsidiary being the parent company. This mechanism, known as ‘expatriation,’ is used by American companies who want to stop paying tax on their international earnings in the United States. How does this strategy come into play? The United States uses the global approach to taxation. The parent corporation in the United States selects a subsidiary in a country that follows the territorial taxation system.
This subsidiary becomes a parent, and the parent corporation in the United States becomes the subsidiary. What is the best way to do this? The parent company in the United States can establish a foreign shell corporation in a tax haven like the Cayman Islands. The shell company issues its shares to the parent company’s shareholders in exchange for the parent company’s shares from these shareholders. In exchange for the parent company’s properties, the shell company may issue its shares to the parent company.
# 8. Conversion of Income:
Since not all forms of income are taxed at the same rate—the tax rate on dividends may vary from that on capital gains or interest income; withholding tax may be imposed on dividend income but not on interest income—this is a tax planning technique.
To take advantage of these distinctions, a holding company can make a loan to a subsidiary and earn interest on it. It then distributes the money to the parent company in the form of dividends. Interest income has been transformed to dividend income. It can also turn dividend income into interest income in the opposite direction.
#9. Avoid Double Taxation
Understanding the foundations of a country’s taxing structures will help you better consider the kinds of circumstances that might lead to double taxation.
Consider a “World Cup Soccer” tournament in which each referee follows his or her own set of rules. Inevitably, conflicts will occur. The game is the same in international tax law. Conflicts occur between countries with distinct taxing privileges, which can lead to double taxation for the taxpayer. In reality, if not handled properly, multiple jurisdictions can levy taxes, potentially resulting in an overall tax rate of more than 100% of income!
Double taxation can occur in a number of ways, including the following:
- Multiple countries claim taxing authority over the start-up: two countries each claim that the start-up is a citizen and taxable in their nation.
- Multiple countries claim taxation authority over the transaction: Two countries claim that the profits from a specific transaction are received in their respective countries and should be taxed accordingly.
- Split tax statement based on party and transaction: One country claims it has the right to tax the start-up because it is a citizen of its country, while the other country claims it has the right to tax because the transactions occur within its borders.
#10. Don’t wait until the last minute.
A systematic long-term foreign tax planning strategy is the perfect way to optimize your financial potential while minimizing tension. That means you can never put things off until the last possible moment! Take your time and prepare ahead.
Start-ups or businesses, as well as their founders or investors, who engage in borderless Internet and e-commerce transactions, outsource intellectual property development, or aspire to establish a foothold in another country and become globally relevant, must deal with tax jurisdiction issues not only for the business but also for themselves and their employees. Because of the complexities and conflicts among international tax laws, an international tax practitioner must be a member of the advisory team.
A full-service accounting firm with international experience can help entrepreneurs develop global businesses by devising effective strategies to reduce tax liability in global operations.
Consult with one of our tax experts to determine which strategy is best for you.