Inbound and outbound investing in Asia: a tax perspective

February 26, 2013

“It is not enough to just concentrate on making investments. It is also crucial to optimize the after-tax returns on these investments.”

Jonathan Stuart-Smith discusses the significant tax trends affecting Asia-Pacific groups investing in and out of the region. Jonathan Stuart-Smith is the Leader of the Global Tax Desks in Asia-Pacific, and the Japan Tax Desk, based in Singapore.

What are the main trends you are seeing in terms of crossborder activity and investment from Asia-Pacific groups?

More and more Asia-Pacific groups are boosting investment, both within the region and beyond. These groups are not only investing in their own backyards, but also eyeing opportunities in emerging markets such as Africa and Latin America, as well as mature markets such as the US and Europe.

This is driven by numerous factors. The Euro crisis and the relative strength of certain Asia-Pacific currencies have led to Asia-Pacific groups capitalizing on investment opportunities elsewhere. Along with demographic and economic development factors, this has led to increasing flows of investment capital from East to West.

These Asia-Pacific groups are extending their footprints offshore through green field investments by building manufacturing, distribution and R&D facilities. They are also taking the mergers and acquisition route to accelerate their expansion.

From a tax perspective, what should these Asia-Pacific groups prioritize as they boost their cross-border investment?

Asia-Pacific groups are becoming more sophisticated regarding group holding and financing structures. It is not enough to just concentrate on making investments. It is also crucial to optimize the after-tax returns on these investments.

This involves Asia-Pacific groups analyzing their existing group structures, and considering whether this is properly aligned within the business. Questions to ask, for example, would be whether there are too many entities, or duplication of functions and activities in multiple companies?

Rationalization of legal entities can create significant cost savings, on a recurring basis. For example, companies headquartered in China can claim a foreign tax credit on dividends received from up to three tiers of foreign subsidiary – so having a structure with four or more tiers can have additional tax costs. This is often relevant in an M&A context, where a Chinese company acquires a group with a complex, multi-tiered structure.

From a financing perspective, it is important that the funding of the local territories is appropriate and efficient. For example, are these groups maximizing their cash flow using strategies such as cash pooling and factoring of accounts receivable?

Specifically from a Singapore perspective, what are the main trends and issues these groups have to deal with in terms of cross-border activities?

From an “outbound” perspective, Singapore groups are increasingly looking beyond the Asia- Pacific region at the US and Europe as investment territories. While Singapore already has an extensive treaty network, the absence of a double tax treaty with the US can reduce the after-tax return on such investments if, for example, 30% US withholding tax is applicable.

Therefore, tax planning is critical to the success of the investment. We are seeing Singapore groups establishing holding companies in countries where they have substance and which have good tax treaty networks, like the UK and Netherlands. From an “inbound” perspective, there is a lot of interest in investing in Singapore, especially groups from the UK, US and Japan.

Singapore’s educated and skilled workforce, as well as its attractive tax incentive regime, are plus points for groups looking to develop and hold their intellectual property here. In the same vein, the excellent infrastructure here makes it an ideal location for managing supply chain activities, such as housing regional procurement and sourcing companies and establishing regional holding companies to manage the group’s activities in Asia-Pacific.

What about Japan? What trends do we see from a Japanese outbound perspective and what issues do those groups face in implementing their strategies?

Japanese groups invested a record amount in overseas mergers and acquisitions in 2011 – to the tune of nearly US$70b, helped by the strong yen. As Japan is a mature economy with an ageing population, growth opportunities are increasingly to be found outside Japan.

Japanese companies are focusing on Singapore as a base for expanding their footprint in ASEAN, India and Australia, from both the supply and demand sides. Japanese groups are establishing production facilities in ASEAN, as well as using Singapore as base to develop new customer markets in the region. This trend has accelerated after the March 2011 tsunami and earthquake.

We are seeing Japanese companies building their presence in Singapore through several means: by housing regional headquarter functions here, developing R&D, trading and even hosting global functions in Singapore. Singapore provides an array of tax incentives, which are of great interest to Japanese companies, but these need to be balanced against Japanese tax considerations, including the Japanese Controlled Foreign Corporation (CFC) rules and transfer pricing rules.

For example, the benefit of securing a tax rate of 5% or 10% in Singapore would be negated if the income was taxable in Japan under the CFC rules, on a current basis and at the rate of 38%. So Japanese companies need to make sure they have the appropriate level of substance in Singapore, to qualify for the active business exception under the CFC rules.

Another example is the transfer pricing rules; a balance needs to be struck, so that both the Singapore and the Japanese tax authorities are satisfied with the pricing arrangements. So, for Japanese as well as other Asia-Pacific groups, overseas expansion offers great opportunities.

From a tax perspective, there are challenges as well as opportunities, which need to be built into the investment thesis.

This article was first published in the Ernst & Young You and the Taxman, Issue 4, December 2012 (pdf, 1.90 MB)

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