Expansion Management Phase: Taxes

“Health Checks”: Your Ticket to Building a Sustainable International Business

This is part 14 of a 17-part series on global expansion. You can find the full list below this article.

Imagine this: you have a business headquartered in the UK. You put all of your strategic employees in the UK, and create an operating model (a guide to regulate behavior to meet your strategy), tax structure (internal and external transactions that help you avoid tax risk) and legal framework (country regulations) that ensures profit and dividends flow efficiently to this headquarters.

One day, you find the perfect candidate to be the new European CEO. But…he’s located in Italy, and refuses to move. 

What would you do?

It might not sound like such a big deal. This candidate is the real deal, and to make it work, you might think he could reside in Italy and simply fly back and forth for work.

That’s exactly what a UK-headquartered company did. The new Italian CEO negotiated with HR for him to stay in Italy and the hiring managers complied without consulting with the tax department. 

From a tax perspective, prior to setting up their new tax structure, legal framework and transfer pricing policy, the UK company agreed the tax and transfer pricing arrangements in this new structure with the UK tax authorities in the form of an Advanced Pricing Agreement (“APA”) (something that should be planned and executed ahead of time with the relevant taxing authority). Allowing the CEO to remain in Italy long term would not be aligned with this agreed upon tax and transfer pricing model. 

When their tax director found out about it (as the taxing authorities likely would as they frequently use Linkedin and people’s description of their roles and job titles to support their positions in tax audits), he became worried. He told hiring managers that they were setting up their company for a huge tax risk in which Italian tax authorities could potentially claim taxes on the UK businesses profits, simply because the core management and strategic activities  of the business were happening in Italian territory. (We like to think of this as the “center of gravity” moving – wherever the brains of your operation goes, the tax model must follow). 

To solve this problem, the UK company had two options: the first was to convince the Italian CEO to move to the UK even though he was adamant not to. And the second was to move their business operations to Italy and align the tax and transfer pricing model accordingly. This would result in a much more inefficient and costly tax position due to the fact that the company had brought forward losses in the UK which they were using to offset against any profits made there thus paying minimal corporate tax. 

In this case they would have had to approach the UK tax authorities and present the new facts and enter into further costly and uncertain discussions to amend the tax position agreed upon in the APA.

Ultimately, the UK company convinced the Italian CEO to move to the UK after one year, which meant their finance department had to record a tax provision on their books for this uncertain tax position due to the potential tax risk associated with the CEO undertaking his work in Italy for that year. You can think of a tax provision as like a rainy day fund where a company makes a note to reserve money in the case they have to pay tax.  

In this example, the hiring team had no idea that they needed to consult with tax advisors to learn how the location of the CEO could have a negative impact on their bottom line and elevate their level of tax risk. The company had no reference guide or checkpoints in place to ensure that the HR department was acting in alignment with the tax model.

Even if you do have a protocol in place early on in your business, you might still find yourself in a situation where mistakes happen. So what can you do to ensure mistakes of any size are prevented? Two words:  “Health Check”.

The Benefits of Health Checks in Creating a Sustainable International Business

There are a lot of different things you need to consider when developing your tax model – the location of your employees, your profit allocation (transfer pricing), the processes within and between your entities, and the model’s alignment with your commercial strategy. But all of this strategy you put into place will hold no value if your company does not follow – and continue to follow – the agreed upon model. 

Take, for example, a US-based company that has presence in many markets around the world, with their global tax function based in the US. We worked with them to tweak their tax model to work in Asia, including helping them set up a regional hub in Singapore with a clear structure in place. Two years later, we discovered that they hadn’t followed the model – they didn’t have the right people in the right places nor were they following the right processes which posed a huge risk across a dozen countries! 

Things change. People will come and go, people will change departments and locations, laws change, and you might grow your product offerings. And when new people assume higher level roles or enter your company, they might not be receiving the knowledge to ensure they aren’t making mistakes that could cost your company. It’s very typical that even large MNCs unintentionally drift away from the agreed upon original model and that’s when the risks start to increase. 

When you create a process or have a control in place, it’ll outlive the turnover of people in your business. Also, having the finance or tax function do a quarterly or annual “health check” to ensure your tax and transfer pricing model is still fit for purpose and aligned with the business and its strategy is key to early identification of any changes and consequent potential risks.  Think of it like routine maintenance checks to assess the health of the business. These health checks require involving the key functions, such as sales, finance, tax, HR, legal and management and needs senior buy-in to ensure it gets executed properly with the right checks and questions being asked of the right people. 

What to include in your health check

If your business is lean, your health check can be as simple as a checklist or a matrix, and the points you are checking should correlate to all key functions within your business with specific do’s and don’ts for the procedures employees are to follow. They should also include looking at where your employees are located, profit allocation, processes between entities, and the model’s alignment with your commercial strategy. If your business is large, you may need to have proactive advisory support to make sure that all stakeholders of the business are inline with the intended tax and transfer pricing model. 

We recommend performing a health check on a quarterly basis to ensure that you’re “living the model” that was originally built. You could work in conjunction with an external or internal operating model effectiveness and tax advisor to make sure that your business activities and strategy remain aligned with your tax model. 

We find that companies will have trouble designing and implementing the health check on their own without a dedicated advisor since perspectives can sometimes be biased, so if you do not have one internally, look for an external consultant. A commercially astute international tax advisor who has had both consulting and in-house corporate experience is also essential in answering questions that can be raised from different departments to help clarify policies versus actual activities, beyond simply assessing that protocols are being followed. 

Keep in mind that the purpose of a health check is not about avoiding or preventing change. You don’t want your business to be static, but agile. You can use health checks as a benchmark when assessing where your company is at and if any parts of your model need to be amended to further align with the growth of your business. And if you do make changes, you can review and update the content of the health check for future assessments.

Your model will only be sustainable if you’re working by the rules and in alignment with the model you’ve set up.  At weConnect, since we partner with you on the backend of your business, we can advise you in advance on what you need to do to stay compliant and help with the design and execution of these health checks. Feel free to contact us here to learn more about staying on track!

With special thanks to Sam Barrett from EY’s APAC Operating Model Effectiveness team for his inputs and insights in putting together this series of articles.

International Business Expansion Series

This article is part 14 of a 17-part series about International Business Expansion. Here’s a list of the full series to give you a well-rounded understanding of what to consider when expanding your business abroad, from strategy to execution to management:

Strategy Phase

  1. The #1 Thing that Companies Need for a Successful Expansion Abroad
  2. The 3 Components of a Market Analysis to Know if Your Product is Viable Abroad
  3. How to James Bond Your Profit Margin with Location Analysis 
  4. How to WIN in a New Market with These 6 Models of Execution 
  5. Risky Business: The 2 Key Layers of your Operating Model to Align with Your Growth Strategy 
  6. Lost in Translation: How Culture Can Impact Your Business Expansion
  7. Show me the money: How to Fund Your Business Expansion Abroad

Execution Phase

  1. You’ve Been Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
  2. Trash Talk: Why You Need to Analyze Your Processes Before Expanding Globally 
  3. 5 Reasons Why You Should Customize Your Technology for Your International Expansion
  4. Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
  5. Landlocked: How your Transaction Flows can Impact Your Access to Funds
  6. 5 Industry-Specific Legal and Regulatory Obligations that can Impact Your Business Expansion Abroad

Management Phase

  1. “Health Checks”: Your Ticket to Building a Sustainable International Business
  2. How Much Is Your Business Worth? 4 Drivers that Increase the Value of Your International Business
  3. Plug and Play: How to Efficiently Scale Your Business When Expanding Abroad 
  4. Beach, or Boardroom? Plan Your Exit Strategy Before You Expand Globally
Resources

Resources

Resources

Expansion Strategy Phase: Funding

Show me the money: Create Your Funding Strategy for Expanding Your Business Abroad

Learn More

Resources

Resources

Expansion Management Phase: Scaling

Plug and Play: How to Efficiently Scale Your Business When Expanding Abroad

Learn More

Resources

Resources

Expansion Management Phase: Assets

How Much Is Your Business Worth? 4 Drivers that Increase the Value of Your International Business

Learn More