Landlocked: How your Transaction Flows can Impact Your Access to Funds

This article is part 12 of a 17-part series on global expansion. You can find the full list below this article.

Want to make cash and then not be able to use it?

We didn’t think so.

Imagine entering a jurisdiction where your local entity does contract with local companies. The entity is performing well and building up a lot of funds that you want to transfer to headquarters.

But you run into a problem…you find out that you can’t get the cash out of the jurisdiction.

This might sound odd; couldn’t you simply do a wire transfer?

Well, it might not be that simple, because in some countries, especially in Asia, there are foreign exchange control rules in place because these countries want to manage the in-flow and out-flows of currency.

When you’re expanding your business abroad, you’ll need to be mindful of your transaction flow model and how it correlates with your operating model. This is important for tax, accounting, and the movement of funds.

For example, you can create a contracting model that determines whether or not business deals you make will be between the client and the local entity or the client and headquarters. In the case where you want to get cash out of jurisdiction to headquarters, contracts between local clients and headquarters would enable you to receive funds without the funds being stuck in the local jurisdiction.

Here are questions you’d need to consider when setting up your transaction flows:

Where do you want your profit to go?

There are a few different ways that companies think of how they’ll be using their profit: 

1. Repatriating their profits
2. Paying off intercompany loans or dividends
3. Reinvesting in the local jurisdiction

You’ll need to think ahead on where you want your profit to go, and then structure your transaction flows and operating model around that goal to make it happen in the most compliant, speedy, and cost-effective way.

If you’re planning on doing one of the first two options (repatriate profits or pay off loans), then the next question you’ll need to ask is how to get cash out of the jurisdiction you’re looking to enter.
For example, if you want to get funds out of China, you will need to show your transfer pricing documentation to prove you are not “shifting profit”, and provide information to substantiate what services you provide and at what prices. The procedure for gaining permission to move funds might take up to six months and require many stamps of approval. During this time, you may wind up getting to build up cash that you can really only use to further invest in China.

One strategy some multinational companies have to receive funds is to create a “management fee” from headquarters under the notion that headquarters is providing support to the local entity. Even though ideas like this can help pull funds out quicker, there are also numerous taxes like withholding taxes and other fees that could become costly, which is why it’s essential to understand where you want your profit to go before you enter a jurisdiction to see if you can structure transaction flows in a better way.

If you are planning on doing the third option (reinvest in the local jurisdiction), then in this case with a country like China, you wouldn’t need to put transaction flows or strategies such as contracting with headquarters nor management fees because leaving the funds within China will make it easier to reinvest prior to taxation.

How will paying off intercompany loans or dividends affect transaction flows?

Another thing you’ll need to consider is how you will fund your business expansion and how you expect to make back money on that investment as you will need to take this into consideration when looking at transaction flows.

If you are funding with equity, then you’re likely getting returns via dividends in the future, for example on an annual basis. Dividend amounts are after tax and sometimes subject to withholding tax, so you’d be receiving less cash.

Loan payments, on the other hand, are paid back with interest and usually have a fixed structure and deadlines on when these payments need to be made. You may opt to create pre-tax transaction flows that allow you to pay off the loans without being heavily taxed in comparison to dividends.

Other tactics some companies use are licensing or invoicing strategies. For example, you could license the technology to your Chinese entity and then earn revenue at HQ from the China entity in the form of license fees. Or, you could have engineers from your parent company help the Chinese entity and then invoice the Chinese entity for this development work. While this is simple, it could also get scrutinized. In China, invoices have unique governmental reference codes so that they can be checked, so creating an invoice is not as simple as designing one on Microsoft Word like in other countries.

What’s the big picture?

Once you’ve asked yourself where you want your profit to go and how that might fit in relation to intercompany loans or equity, it’s time to look at the big picture, especially if you plan to have your business set up in multiple locations.

For example, let’s say you’re looking to expand from Europe to Asia. You could set up your Asia headquarters in Singapore and then expand into other countries within APAC. Depending on the tax policies within each jurisdiction, you could have different contracts set up for your transaction flows depending on your profit allocation and tax goals. For example, you could have Korean and Japanese customers contract with your main headquarters in Europe, whereas your other contracts throughout Asia could be set up with your headquarters in Singapore. Within this setup, you’ll need to have agreements in place for transfer pricing, the appropriate value and functions exists in the Europe HQ and the Singapore Asia HQ to support the different contracts, and make sure that all entities and teams are aligned. That means, not only your Europe HQ but also your Singapore entity will need to have substance (e.g hire staff, perform functions, add value), meaning it cannot just be a paper company.

This topic can be complex and the strategy you use depends heavily on your business. It’s essential to have a tax professional involved when you’re setting up cross-border businesses; we can help by asking you the right questions you’d need to consider. Plus, we can work with you to build you an effective tax and operating model strategy so your funds flow between your global entities as smoothly as the Amazon river! Feel free to contact us here.

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 12 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. Lost in Translation: How Culture Can Impact Your Business Expansion
6. Show me the money: How to Fund Your Business Expansion Abroad

Execution Phase

1. Risky Business: The 2 Key Layers of your Operating Model to Align with Your Growth Strategy 
2. Avoid Being Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
3. Trash Talk: Why You Need to Analyze Your Processes Before Expanding Globally 
4. 5 Reasons Why You Should Customize Your Technology for Your International Expansion
5. Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
6. Landlocked: How your Transaction Flows can Impact Your Access to Funds
7. 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