With an increasing number of women holding cross-border leadership positions and investing in offshore businesses—as founders, entrepreneurs, investors or executives—understanding the tax implications of domestic and international corporate structures has become increasingly relevant and important.

Investing overseas can open a world of opportunity for Australian investors, but it also brings a host of tax considerations that can significantly impact returns if not properly managed. The Australian tax system requires residents to report and pay tax on their worldwide income, including foreign investment earnings—something that catches many investors off guard. From the complexities of foreign income tax offsets and double taxation agreements to the pitfalls of not declaring overseas assets or income, there are several traps that can lead to unexpected tax bills or penalties.

In this article, we delve into the key considerations for Australians investing abroad and highlight common traps to ensure compliance, minimise tax liabilities and make the most of your international investments.

There are a range of Australian tax regimes which are relevant to outbound investment structures—that is, for Australian tax residents investing overseas. This includes the following (though there are others which could be relevant, and we encourage you to seek the appropriate tax and legal advice):

The Australian tax implications associated with inbound investments is outside the scope of this article, but should you be interested in finding out more, please do not hesitate to contact the authors.

References to the “Tax Act” are references to the Income Tax Assessment Act 1936 (Cth) or the Income Tax Assessment Act 1997 (Cth), as appropriate.

Controlled Foreign Company Rules

The Controlled Foreign Company (CFC) rules are contained within Part X of the Tax Act and are an integral part of Australia’s international tax regime. The broad purpose of these rules is to tax Australian shareholders of a CFC on their share of the CFC’s tainted income (essentially, passive income, such as interest, dividends and royalties) as it is accrued (rather than when it is remitted to the Australian shareholders), unless that income is comparably taxed offshore or the CFC derives its income almost exclusively from active business activities.

Under Section 340 of the Tax Act, a company is a CFC at a particular time if, at that time, the company is a resident of a listed or unlisted country and any of the following apply:

It is important to note that a “control interest” includes both direct (i.e. directly held shares) and indirect (i.e. interest in a foreign company through an interposed entity) control interests. Where there are different percentages in each of the above, the control interest is the greater or greatest of those percentages (see Subsection 350(2) of the Tax Act). This makes the test more broad and easier to fall under.

Where a foreign company is a CFC, certain categories of income must be attributed to its Australian resident controller—that is, tainted income or eligible designated concession income. For completeness, please note that accruals taxation will not generally apply to income derived by CFCs that pass the “active income test” (i.e. CFCs that derive more than 95% of their income from genuine business activities offshore).

Australia’s Tax Treaties

Australia has entered into Double Tax Agreements (DTA) with more than 40 jurisdictions. DTAs ensure that individuals and businesses do not get taxed twice on the same income—once in the country where the income is earned and again in the country of residence.

Where an Australian tax resident operates or invests in a jurisdiction with which Australia has a DTA, the DTA determines which jurisdiction has taxing rights over the income or gains generated, and  provides concessional withholding tax rates on certain types of income, such as interest, dividends royalties.

Foreign Hybrid Entities

The foreign hybrid rules contained within Division 830 of the Tax Act are Australia’s response to cross-border mismatches where an entity is characterised differently for tax purposes in two jurisdictions, one of which is Australia. For example, a UK limited liability partnership is treated as a company for Australian tax purposes, but for UK tax purposes, it is treated as a flow-through or transparent entity so that the partners are taxed on the income and not the partnership.

Foreign hybrids are treated under Division 830 as partnerships for Australian tax law purposes, which means that the members of the entity will be subject to Australian tax based on their marginal tax rates on income derived by the partnership as opposed to the partnership itself being taxed. A “foreign hybrid” is defined for these purposes as a “foreign hybrid limited partnership” (e.g. a UK LLP) or a “foreign hybrid company” (e.g. a US LLC).

These rules are of particular relevance to investors and entrepreneurs who use or invest in international vehicles, such as limited liability companies or partnerships in jurisdictions like the United Kingdom or United States. We have seen these structures frequently used in private equity, technology startups and family office arrangements (to name a few).

Foreign Income Tax Offsets

When Australian tax residents derive foreign-sourced income that is taxed overseas, they may be eligible for a foreign income tax offset in accordance with Division 770 of the Tax Act.

Transfer Pricing

Transfer pricing refers to the pricing of goods, services or intellectual property transferred between related entities. For example, when a subsidiary of a company in one country sells products to a parent company or another subsidiary in a different country, the price charged is called the transfer price. Transfer pricing issues generally arise where related entities trade with each other.

When unrelated parties transact with each other, the conditions of their commercial and financial relations ordinarily are determined by market forces. When related enterprises transact with each other, their commercial and financial relations may not be directly affected by external market forces in the same way, although associated enterprises often seek to replicate the dynamics of market forces in their transactions with each other.

The mischief which transfer pricing rules attempt to address is where the pricing between entities, i.e. transfer pricing, does not reflect arm’s-length terms and more income is directed to a lower tax rate.

As with most Organization for Economic Co-operation and Development jurisdictions, Australia’s transfer pricing rules are based on the “arm’s-length principle.” Broadly, the arm’s-length principle attempts to adjust taxable profits to the level which would arise between related entities if they had been exposed to market forces. These rules are contained within Subdivisions 815-B, 815-C and 815-D of the Tax Act.

Companies are required to maintain contemporaneous documentation in relation to related-party cross-border transactions and a transfer policy.

The international tax landscape is constantly evolving, and what works today may become a trap tomorrow. Staying informed, maintaining robust documentation and seeking expert advice are essential strategies for long-term success in the global marketplace. With careful planning and awareness, tax challenges can turn into strategic advantages.

Betsy-Ann Howe
Partner Sydney
K&L Gates
Profile

Naeha Lal
Senior Associate Sydney
K&L Gates
Profile