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.
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.