As the service export industry evolves, businesses face many unique challenges to deliver them. Some of these issues may look familiar to those experienced in exporting commodities, while others are tax considerations and compliance provisions that relate directly to the service exports industry.
Here’s what you need to consider when sending employees to represent your company by delivering services in person in foreign locations.
The 3 types of taxes you need to plan for
The three primary tax considerations are: 1. permanent establishment risk, 2. local withholding tax, and 3. personal income tax.
Let’s look at each of these in more detail.
1. Permanent establishment (or PE) risk arises when employees working for a company located in one country start doing things that trigger corporate income tax in a foreign country. Governments everywhere will try to tax productive activities whenever they can. Certain de minimis activities are allowed (usually spelled out by a tax treaty between the two countries), but once that threshold is crossed, local authorities will attempt to assess income tax on the local activities.
Among the 38 countries that are members of the Organization for Economic Control and Development (OECD), there is an agreed set of standards. Typically, employees of an American or Canadian company (both are OECD treaty members) can spend a total of 181 days in a foreign country before a permanent establishment is created.
Beware that travel days are included, and the days do not need to be consecutive. Some companies fail to track this, and fall into the PE trap when projects are extended or run into delays. Other company activities in the local country may make this 181-day threshold less certain, so make sure you obtain good international tax advice.
2. Withholding tax arises when a foreign worker earns more than a maximum local tax withholding threshold in the foreign country. Even though this employee is paid by the company in their home country, the local foreign country will attempt to attribute a value to the services each foreign worker is providing in that country. If the value exceeds the local threshold, then the employer will be required to pay withholding tax on that amount.
It may be interesting to note that Canada has one of the lowest withholding tax thresholds in the world, a fact that has tripped up many U.S. companies who send their workers into Canada on projects.
If the destination country’s thresholds are exceeded, it may be possible to file for an exemption from this withholding tax, or file for a refund later. In some cases, it will just be an additional cost of doing business that needs to be factored into project/services pricing.
3. Personal income tax can also become an issue. The situation is the same as an employee of an American or Canadian company who resides in one state/province but works a substantial period of time in another. The individual in this case will receive two state W2s, and therefore must file state/provincial income returns in both jurisdictions.
The difference in international cases is that the employee’s individual tax preparation will become far more complicated. The employer will typically provide the employee with the necessary international tax advice to help them prepare these returns.
Thoughtful employers also ensure that the employee is appropriately compensated financially, as the tax rates in the destination country could be substantially higher than in the employee’s home country.
2 key rules to operate under
1. Involve your tax team early in the planning process; if you don’t have an in-house tax resource, help educate your finance team so that they understand the importance of getting good external international tax planning advice.
2. Be aware of key thresholds and closely track against them; make sure you have an alert system that lets you know when you are getting close, but have not yet exceeded them, so that you have time to explore and implement alternatives.
Export compliance still applies to services
Export compliance issues need to be considered if the service providers carry laptops, USB drives, or other portable media with encrypted software into a foreign country. Depending on the destination country, there may be export restriction issues, or even licensing issues. (Many times, these employees will access such software remotely, which also creates export compliance questions, but we’ll talk about providing services remotely in a future article).
In addition, the type of project and the destination country will need to be checked against country restrictions. If the service supports a product, the customer should already have been checked against any list of denied parties or other known bad actors. If there is no related product, the local customer should have been screened against these lists prior to bidding on, or contracting for, the project/services.
Sometimes, while actually executing a project, it becomes clear that some sort of assistance may be needed from a local firm. In this case, your company must have a process for ensuring this company and its principals are also screened.
1. If the services are related to any kind of product sale, make sure you consider all the necessary related services BEFORE you sell the product to a particular country. Do this so that you can consider any export issues related to the services as part of the product sale – don’t just evaluate the exportability of the product alone.
2. Have a system for checking the software on travelers’ computers for any export compliance issues.
Seek help from experts in the local laws
This is a broad category, and is difficult to generalize much because local laws vary widely from country to country, and are also highly dependent on your industry vertical.
Here are a few general recommendations:
1. Make sure your travelers are aware of driving restrictions and traffic laws. Make sure they understand what they need to do in the event of an accident.
2. Provide guidance to them on any specific laws that may affect them (e.g. chewing gum in public in Singapore), as well as cultural sensitivity training and local “do’s” and “don’ts”.
3. Make sure travelers understand what do if they need medical treatment.
4. Make sure your insurance broker is informed of the travelers’ activities so that the appropriate coverage is extended.
To address some of these risks, a good internationally-experienced travel agency, as well as a similarly-experienced insurance broker can be invaluable resources.
Someone who can provide detailed cultural training can also be helpful. If you are regularly sending people overseas to provide services and you don’t have these resources at your fingertips, it may be time to re-look at your service providers to make sure they have the right skillsets to help you.
The service export industry is growing rapidly around the world, and as it does things aren’t getting any simpler for those involved. Companies sponsoring employees traveling to provide service exports will need to have strong compliance programs in place to make sure they follow the applicable laws and that the risks are properly managed.