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Nexia Ebner Stolz

Tax Advice

The legal and tax framework when doing business abroad

The German midmarket is heavily involved in foreign trade. According to a study by KfW, more than two-thirds of medium-sized firms in Germany actively export to foreign markets. The number of midmarket companies with direct investments abroad is also growing. In many cases, proximity to certain sources of raw materials, major customers, and strategic transport hubs are key factors in a company’s decision to do business abroad.

Once the busi­ness deci­sion has been made, the legal frame­work has to be defi­ned before any inter­na­tio­nal acti­vity can take place - irre­spec­tive of whe­ther the ven­ture is a for­eign pro­duc­tion faci­lity, an assem­bly pro­ject or a sales office abroad. Any com­pany that does busi­ness in a for­eign coun­try must deal with a mini­mum of two legal sys­tems and com­pe­ting tax regi­mes. And whe­reas com­mer­cial ope­ra­ti­ons wit­hin the EU are rela­ti­vely simple from a legal stand­po­int, when it comes to taxa­tion at least two fis­cal aut­ho­ri­ties need to be satis­fied.

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Com­pa­nies inten­ding to do busi­ness beyond EU bor­ders would be well advi­sed to choose a coun­try with a sta­ble, straight­for­ward legal sys­tem. As actual cir­cum­stan­ces often nar­row this choice, invest­ments rou­ti­nely involve impon­dera­b­les that are vir­tually impos­si­ble to hedge against. In such cases, it can be use­ful to col­la­bo­rate with inve­s­tors who have already gone down this road.

Many coun­tries clo­sely regu­late the con­di­ti­ons under which for­eign acti­vity may take place. Often, a for­eign branch or even a sub­si­diary must be foun­ded if a com­pany is to be allo­wed to ope­rate in the coun­try for a lon­ger period of time. In Bra­zil, for example, an inves­tor is not allo­wed to hire staff wit­hout having first set up a sub­si­diary or branch office. Like­wise, the lia­bi­lity pro­tec­tion that is usually requi­red can only be achie­ved by estab­lis­hing a for­eign com­pany. The legal form should the­re­fore be con­s­i­de­red care­fully, parti­cu­larly in the Uni­ted Sta­tes. The next step is to iden­tify the most favora­ble tax struc­ture. Here, for­eign part­nerships are gene­rally advisa­ble. Howe­ver, as these do not enjoy any­t­hing like the level of accept­ance in the rele­vant mar­ket that a GmbH & Co. KG (a form of limi­ted part­nership in which the gene­ral part­ner is a Ger­man limi­ted lia­bi­lity com­pany, a GmbH) does in Ger­many, it can be dif­fi­cult to achieve a balance bet­ween legal sim­p­li­city and tax bene­fits.

From an admi­ni­s­t­ra­tive and bureau­c­ratic per­spec­tive, for­eign ope­ra­ti­ons are most easily con­duc­ted by set­ting up an inde­pen­dent cor­po­ra­tion. While this is not always the option with the grea­test tax bene­fits, it has the advan­tage that the com­pany is a resi­dent tax­payer in the coun­try in ques­tion and is gene­rally also trea­ted by Ger­man share­hol­ders in the same man­ner as other local com­pa­nies. In the majo­rity of cases, pos­si­ble legal cons­traints for for­eig­ners do not apply when this legal form is cho­sen. Pro­fits gene­ra­ted by a for­eign cor­po­ra­tion are nor­mally sub­ject to local taxa­tion. The regu­la­ti­ons in place in the for­eign coun­try are used to cal­cu­late pro­fits and for finan­cial repor­ting. Where the for­eign sub­si­diary dis­tri­bu­tes pro­fits to Ger­many, taxa­tion in Ger­many depends on whe­ther the sha­res are held by a pri­vate indi­vi­dual or part­nership or by a cor­po­ra­tion. In the first case, the dis­tri­bu­tion of pro­fits will be sub­ject to the par­tial-income taxa­tion method (Tei­l­ein­künf­te­ver­fah­ren), where only 40% of the rele­vant ear­nings will be exempt from tax in the future. If, howe­ver, the share­hol­der is a Ger­man cor­po­ra­tion, Ger­man cor­po­rate income tax will ini­tially not be char­ged. Only five per­cent of the pro­fits dis­tri­bu­ted will be trea­ted at non-deduc­ti­ble expen­ses at the Ger­man share­hol­der. Depen­ding on natio­nal regu­la­ti­ons, with­hol­ding taxes on divi­dends may be added and then ideally redu­ced to zero in accor­dance with the rele­vant dou­ble taxa­tion agree­ment. Here, advance plan­ning is vital.

If, on the other hand, only a per­ma­nent estab­lish­ment or a part­nership is for­med in the for­eign coun­try, any pro­fits of this com­pany gene­ra­ted abroad will be taxed in accor­dance with the regu­la­ti­ons in place there. Where this com­pany is the for­eign branch of a Ger­man cor­po­ra­tion, it is gene­rally sub­ject to for­eign cor­po­rate income tax. If the branch is owned by a Ger­man sole pro­prie­tor or a part­nership, income tax is often char­ged in the for­eign coun­try. Where a dou­ble taxa­tion agree­ment exists bet­ween the for­eign coun­try and Ger­many, the for­eign income is nor­mally tax exempt in Ger­many with pro­gres­sion. This per­mits the for­eign tax level (which will ideally be lower) in this struc­ture to fil­ter down to share­hol­der level.

Finally, you will have to put arms and legs on the for­eign struc­ture you choose, which means having staff and office equip­ment on the ground. Here, it is a good idea to use exis­ting long­stan­ding for­eign part­ners with whom you have estab­lis­hed a rela­ti­onship of trust. In many cases, staff from the com­pany in Ger­many will have to be sent abroad to advance the for­eign ope­ra­ti­ons locally, wor­king in con­junc­tion with local staff. Where emp­loyees are pos­ted abroad, you will need to con­s­i­der the legal aspects of their resi­dence sta­tus, work sta­tus, taxa­tion, and social secu­rity, which due to the com­ple­xity and inte­g­ra­tion of dif­fe­rent areas to be regu­la­ted are very dif­fi­cult to resolve wit­hout expert advice.

We invite you to find out what other aspects need to be taken into con­s­i­de­ra­tion in a for­eign acti­vity and how we can sup­port you in your endea­vors.

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