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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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