Expanding abroad -
Recognizing and avoiding tax pitfalls
Despite discussions about de-globalization, foreign business offers numerous opportunities for many companies. Expanding abroad therefore remains an interesting option for tapping into new markets.
In addition to the tax burden abroad, the choice of location depends on many other factors: Availability of employees, salary levels, infrastructure, geographical location, currency and political stability, to name but a few.
When expanding abroad, many companies usually focus on foreign countries. Companies are particularly attracted by the low tax rates abroad. However, there are also tax challenges in Germany that need to be considered.
In this article, you will learn how to recognize and avoid tax pitfalls in order to prepare your company for expansion.
Overview
How to recognize and avoid tax pitfalls!
Place of management
Foreign corporations can also become liable for tax in Germany. This always applies if the place of management is in Germany and not abroad.
Generally speaking, the state in which the actual place of management is located has the right to tax the profits of the corporation.
The decisive factor is where the day-to-day business is carried out. Careful consideration should therefore be given to where the company’s important decisions are made. Decisions should not just be made on paper, but should be reflected in reality.
Questions to be clarified in this context are:
- What are the day-to-day business decisions in your case?
- Who makes these decisions?
- Where are these decisions made or ordered?
Practical tip: The tax problem can be solved by appointing several managing directors, with one managing the day-to-day business abroad.
Transfer of assets
The foreign company is usually equipped accordingly when it is founded. This includes tangible and intangible assets that belong to the German company and are made available to the foreign company.
In addition, the foreign company must also be assigned a specific task in the form of an activity or function (e.g. sales, purchasing, financing, research and development).
Generally speaking, this means in tax terms:
If an asset or function is transferred abroad, this leads to German taxation through the disclosure of the associated hidden reserves (exceptions to this may exist). Accordingly, careful consideration should be given to which assets are transferred and the value of these assets.
In particular, the so-called transfer of functions should be mentioned in this context, which can lead to significant tax consequences in an international context.
Relocation of functions
In practice, the issue of the relocation of functions is often underestimated. However, it is a significant issue, particularly with a potentially high tax burden for the German company.
What exactly is a functional relocation?
A transfer of functions always occurs when a function previously performed by a company is transferred to a related party abroad (§ Section 1 (3b) AStG ). If this is done free of charge and the profit of the German company is reduced by the transfer of functions, the taxable profit in Germany is adjusted.
It must therefore be ensured that an arm’s length purchase price is agreed for the transferred assets and other benefits.
This regulation is based on the following question:
Would you transfer an operational function of your company to a third party without demanding a purchase price?
Against this background, appropriate considerations and calculations are required prior to expansion in order to avoid or minimize the tax burden.
Add-back taxation
In simple terms, add-back taxation is a regulation designed to prevent companies from shifting profits to countries with low tax rates without actually being economically active there(Section 7 AStG, Section 8 AStG).
In Germany, this means that profits from foreign subsidiaries are attributed to the German parent company under certain conditions and taxed there.
As a rule of thumb, in order to avoid add-back taxation, the foreign company must have an operating and active activity with a certain substance in order to benefit from the low foreign tax rates.
For more details, please refer to my blog article “Add-back taxation – understanding and averting tax traps”.
Transfer prices
There are usually service relationships between the domestic parent company and the foreign subsidiary, which must also be thought through and documented.
Such service relationships are the focus of tax auditors with regard to so-called transfer prices.
In brief: Transfer prices are the prices charged between related companies for goods and services.
Internationally active companies must choose prices according to the so-called “arm’s length principle”. This means that prices must be set in the same way as they would be agreed between independent companies.
Accordingly, expansion abroad requires the determination of arm’s length prices in the case of service relationships. Appropriate contracts and documentation are required.
PRACTICAL TIP
- Expansion abroad always requires tax planning in Germany in order to avoid a tax burden at German level. Simply looking abroad is not enough.
- First of all, ask yourself: What specific task should the foreign company fulfill? To what extent does the company abroad need support from Germany?
Are you planning to expand abroad with your company and need tax advice?
I will be happy to support you in planning and implementing a tax-optimized structure.
Please feel free to contact me!
Disclaimer
The article uses simple language for better understanding and is also abbreviated with regard to the individual conditions required by law.
This article does not constitute legal or tax advice, but is for general information purposes only. Every situation is individual, so I always recommend professional advice to avoid tax disadvantages.
Last updated September 13, 2024
