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GST planning for outsourcing and offshoring

It is widely accepted that in our present era globalisation of trade and business has dramatically escalated economic development. The developing world is leaping forward towards economic prosperity at a pace not imaged a few years ago.

Growth in the developing countries is taking place at a rate that is about double the rate being achieved in the developed world. In the SMH article, "The shock of the new world economic order", late 2006 statistics from The Economist are used to support the statement: "Developing countries now account not for 20% of gross world product but more than half."

A Golden Age for the developing world has arrived on the back of globalisation and technological innovation. Outsourcing or offshoring has become an integral part of current globalisation trends.

The flip side of all this is that businesses in the developed world are contracting out some of their production and back office functions to businesses in developing countries.

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World GDP growth. Source: IMF and Australian Treasury.

The mere mention of outsourcing, especially offshoring, conjures up images of call centres in India and factories in China.

The legal systems operating in these countries do not resemble those in Australia and therein lies one of the traps and pitfalls for Australian businesses.

Differences in legal systems and the integration in world business of business transactions and business functions makes it imperative to monitor international legal developments, including changing taxation laws and tax rates in various countries.

Monitoring international tax developments relevant to outsourcing and offshoring is relevant to business enterprises:

  • when considering a new offshoring or outsourcing contract;
  • when reviewing or re-negotiating existing contracts; and
  • when action is need to respond to GST rate changes.

One type of tax to consider and monitor in outsourcing or offshoring is consumption tax consequences impacting contracting. To illustrate issues, the balance of this article focuses on consumption tax in the context of outsourcing or offshoring.

1.        What is a consumption tax?

Most countries now implement tax based on consumption or turnover. Although the principles on which such tax regimes are built are identical (that is taxing consumption), businesses cannot afford to ignore their differences in particular instances, especially when contracting across national boundaries.

Basically, GST (ie goods and services tax, or as is sometimes called, VAT) is charged on the supply of goods and services and is payable by the supplier. The supplier builds the GST payable into the price payable by the purchaser of the supply.

If the purchaser is in business, a claim for credit of the GST paid will become available to the purchaser.

If all this happens in one country suppliers and purchasers will not be out of pocket, provided they are in business. Problems arise if the supplier and the purchaser are in different countries and the legal rules and rates applicable to GST (or VAT) are not the same.

The problem calls for regular monitoring given that there are occasional changes in rates and thresholds over which GST (or VAT) becomes chargeable.

Two examples of those changes in consumption tax rates arose recently in countries in Asia to which services are increasingly outsourced by Australian enterprises.

 
  • Last week the Government of India announced that it will increase the exemption threshold for service tax applicable to small service providers, from Rupees 400,000 to Rupees 800,000.
    • The increase means that an Indian service provider will become liable for service tax only after its turnover exceeds Rupees 800,000. This will invariably result in a decrease in service tax payable by the Indian service provider, thus increasing the net revenue obtained from a contract by an Indian service provider.

    • The decrease in tax payable is a factor worth considering in determining the outsourcing or offshoring contract price. It is a matter to detect and exploit in contract negotiations.

  • Last month's Singapore Budget 2007 proposed an increase in GST from 5% to 7%, effective from 1 July 2007.
    • The Budget also proposes a decrease in the corporate tax rate. The effects of the changes to Singapore GST and corporate tax rates are opposite to each other, but not equal in value.
    • This is a matter requiring review on a case by case basis.

2.        Cross-border supplies and Australia's "reverse charge"

Another important consideration in relation to cross-border transactions is the "reverse charge" provisions in Australia's GST law.

The concept is called reverse because unlike in normal circumstances where GST is payable by the supplier (who gets the money for selling something), GST is made payable by the recipient of the supply (who pays the money for the supply).

The GST provisions on "reverse charge" were intended to discourage the conventional view that it is GST efficient to procure business services inputs from abroad than from suppliers in your own country (eg Australia). If services are obtained from abroad, the recipient of the services is required to pay GST on the supplies and then claim the input tax credit, just as if the services were obtained from a local supplier.

In a multi-jurisdictional context when supplies are obtained from abroad it is vital the following issues are reviewed:

  • divergent treatment and characterisation of the services for GST purposes in different jurisdictions;
  • achieving the most efficient GST operational and management aims of a business; and
  • impact of GST consideration on deal structures.

3.        Characterisation of supplies

This becomes important if supplies are made to persons in Australia and payment for such supplies are made by persons in Australia.

Different countries have different ways of characterising supplies. If the supply is characterised as resulting in royalty payment in Australia, a withholding tax will apply to the payment. This means the payer for the supply is required to deduct the tax and pay it to the Australian Tax Office.

gst_&_withholding_tax

If the agreed contract price is $110 and the supplier abroad assumes that it will have $110, the result

may not be as pleasing as that.

GST credit will be available to the Australian payer and not to the supplier abroad. These implications should be brought home to the supplier in time, so that friction and unpleasantness are avoided at a later stage of commercial relationships.


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