Why You Should Consider Setting Up a Foreign Company

Foreign Company Setup – For Online Businesses

Are you a digital nomad or Australian expat wanting to know more about setting up a foreign company?

If you set up a foreign company, you will be taxed on the profits if your company has a permanent establishment (PE) in a specific country. However, if you’re selling services or digital goods online, you may not have a permanent establishment and may not be subject to corporate taxes (more on that in a moment).

If you’re an Australian expat or digital nomad, there are many benefits to owning a foreign company. It creates more flexibility, makes it easy for you to accept foreign payments, and provides asset and liability protection.

Note: If you’re operating through an existing Australian company, you’ll need to have at least one director residing in Australia, which can be difficult for Australian expats living overseas.

Option 1: Set Up a Company in the Country Where You Live

I don’t recommend opening and operating a local company in the country where you live unless it has strong economic stability and allows you to connect it with Stripe. However, there are some benefits to setting up a basic local company like:

• Visa Options: You can often employ yourself through a locally owned company, which may help you secure a temporary work or residence visa (check the local country’s rules around this).
• Health Insurance: In some countries, you can pay yourself the minimum wage including taxes, which makes it easier to access local healthcare.

Permanent Establishment (PE) and Tax Implications

A Permanent Establishment (PE) is defined under the OECD model as: a fixed place of business through which the business of an enterprise is wholly or partly carried on. This is a broad definition and each country has it’s own specific wording and applications. Generally, a “fixed place of business” includes a permanent office, shopfront, or inventory storage. It may include a place where you sign business contracts or perform services for 6+ months. If you have a PE in another country, you’re liable to pay taxes there.

It doesn’t really matter where your company is incorporated, it matters where your “fixed place of business” is. However, if you run an online business or sell digital goods, it becomes tricky to determine where your PE is.

• PE Rule: Most countries apply the PE rule in similar ways. It often applies if you carry on a business from a fixed place in your country of residence.
• Excluded Activities: Preparatory or administrative tasks are usually excluded from PE.

Wherever you operate from – the tax man follows. That’s why the next step is so important.

Consider Both Personal and Corporate Tax Rates

Your company strategy needs to consider both personal and corporate tax rates wherever you reside. Your personal tax rate is the most important.

• Small Business Relief: Some countries offer tax relief if you’re a small business or startup company, such as Nicaragua’s 10-year tax relief for free trade zones (FTZs).
• Low-Tax Jurisdictions: Dubai has no individual income tax and a low corporate tax rate of 9% for businesses generating over 375,000 AED (currently $152,000 AUD). There are many other places like Monaco, The Bahamas, and Vanuatu where there are no income taxes.

Option 2: Set Up a US LLC

A US LLC (Limited Liability Company) is the easiest foreign company to set up, especially if you’re an Australian expat or digital nomad living overseas. As a foreign-owner of an LLC, you generally don’t have to pay company taxes in the US unless you are operating a business in the US or employing US staff or contractors.

Setting up a US LLC is much simpler and cheaper than other countries (like Hong Kong or Singapore), which is why it’s a popular choice for expats and digital nomads. It’s fairly inexpensive, the IRS has a fast turnaround time, and you don’t have to fly to the US to set it up.

You can either register the company yourself (there are lots of websites that offer this service) or you can work with an accountant who can manage it all for you.

Once you’ve set up a US LLC, you’ll have to file IRS reports 1120 and 5472 every year, otherwise you’ll get hit with huge penalties (up to $25,000 USD). You’ll also need to register your “Articles of Incorporation” with the US state where you set up your company. This is because the US has both Federal and State registrations.

You’re also required to keep accounting records of all your transactions, which you then use to fill out the annual IRS forms (similar to Australia).

Benefits of a Foreign Company

1. Simplicity and Popularity

• Easy Setup: The process of creating a US LLC can often be done online in a matter of days, depending on the state you choose. Wyoming and Delaware are usually the best for foreigners.
• Low Costs: Forming a US LLC is usually inexpensive (around $500-600 USD if you do it yourself), with low state fees and ongoing costs for keeping your LLC active.

2. Flow-Through Entity: Tax Flexibility

A 100% foreign-owned single member US LLC is treated as a flow-through entity for tax purposes, which means that the income generated by the LLC flows directly to the owner (at your discretion). The owner then reports the income on their personal tax return and pays income tax based on where they live. This creates a lot of flexibility because you can choose how much to pay yourself from your company.

• No US Taxes for Foreign Owners: If you operate a foreign-owned LLC, you generally don’t have to pay US taxes if your income falls into a foreign-sourced category.
• Tax When You Withdraw Income: You pay taxes on the income when you withdraw it from the LLC, and those taxes are paid based on your residency, not US tax law.

3. Connect to Stripe for Payments

One of the main benefits of setting up a US LLC is the ease of connecting it to payment gateways like Stripe, PayPal, or other international payment processors. This means you can receive payments from anywhere in the world, even if you move countries!

• Easy Processing: US LLCs are recognised by major platforms, so it’s easy to set up your LLC with Stripe to receive international payments.
• Less Restrictions: Stripe favours US LLCs over smaller countries because of the economic stability and reputation of the country.

4. Minimal Annual Reporting Requirements

As I mentioned earlier, foreign-owned single-member LLCs are required to comply with specific annual filing obligations. Every country has similar reporting requirements, whether you have a company in the US, Singapore, Hong Kong, or Dubai. However, the annual IRS reports are for data purposes only, they’re not tax returns.

• Form 1120: This is an informational return, which acts as a cover sheet for Form 5472. It must be submitted even though no income is reported.
• Form 5472: This form is used to report all business transactions between the foreign owner / related parties and the LLC, such as capital contributions, loans, or distributions. If you fail to file Form 5472, the IRS can issue fines of up to $25,000 per year, so it’s super important to submit everything correctly.
• Beneficial Ownership Information (BOI): This is required since 1 January 2024 and includes the collection and disclosure of the identifying individuals who beneficially own or exercise substantial control over an LLC or US entity.
• State Forms: Depending on where your LLC is incorporated, you will need to submit state forms each financial year.

5. Single or Multi-Member Options

You can choose to form a single-member LLC or bring in additional members to create a multi-member LLC (acts as a partnership structure).

• Single-Member LLC: Treated as a disregarded entity for tax purposes, meaning it operates similarly to a sole proprietorship with flow-through taxation. However, you get the benefits of limited liability protection.
• Multi-Member LLC: This is like a partnership. The income is split among the members according to a percentage. Each person is then taxed on their share of the profits. Note: There are different IRS forms needed for this setup and it’s a bit more complicated than the single-member LLC setup.

6. Liability Protection

One of the key reasons for setting up an LLC is the protection it offers to your personal assets. If you were dealing with a lawsuit or financial trouble, the LLC protects your personal assets from being accessible. There are certain circumstances where you may be personally liable for the company’s debts, like fraudulent activities or using the company bank accounts for personal expenses.

• Shielding Personal Assets: If your business gets sued, creditors can usually only go after the assets of the LLC, not your personal property. Having a holding company can offer additional protection.
• Peace of Mind: This structure provides expats and entrepreneurs with more security, especially if you’re operating internationally.

7. Insurance and Holding Companies

Insurance adds another layer of protection for your LLC. It’s also very easy to get insurance for your LLC compared to other countries. As your income increases, you may want to set up a holding company to transfer the profits into from your main LLC. This keeps the assets in your trading company low, which provides more protection in the event of a lawsuit. Ideally, you want to move the trading profits out of the main company and into your personal name or a separate LLC.

• Business Insurance: You can find comprehensive business insurance to cover your LLC’s operations.
• Holding Companies: Setting up a holding company to own your LLC can further protect your assets and business profits.

8. Privacy

Unlike in Australia, if you set up a US LLC, especially in states like Delaware and Wyoming, there are privacy protections available for you as a business owner.

• Minimal Disclosure: You can keep your personal information private. Some states don’t require the names or addresses of LLC owners to be publicly disclosed. This provides another layer of protection.
• Anonymous Ownership: In certain states, your LLC can maintain a level of anonymity, which provides peace of mind around your personal privacy.

Despite all these benefits, a foreign company or US LLC is not for everyone. Next, I’ll list some of the challenges around setting up and managing a foreign company.

Challenges of a Foreign Company

Running a foreign company can be challenging, especially in the beginning. Things can quickly become complex when it comes to reporting and tax implications.

1. Annual Reporting Obligations

As mentioned previously, foreign-owned US LLCs (and other foreign companies) are subject to annual reporting requirements. Form 5472 and 1120 must be filled out and submitted each year to the IRS, even if no income is earned or reported in the US.

2. US Operations = Taxable Income

You can operate tax-free in the US—as long as you don’t conduct business on US property or hire US employees. The moment you begin operating in the US, things change rapidly.

• US Taxes: If you hire US employees or operate from a US location (i.e. a warehouse or office), your LLC will be subject to US taxation. This shifts your LLC from a simple flow-through entity for foreign income into a more complex entity with US tax issues.
• Additional Reporting: Operating in the US triggers additional reporting requirements beyond Form 5472, including potential state tax filings, payroll taxes for US employees, and other federal tax obligations.

I recommend keeping your operations out of the US if possible, as it simplifies your tax and reporting situation.

3. Tax Challenges in Your Local Country

Even though your LLC income might be tax-free in the US, you’re still responsible for reporting your company income and any owner’s distributions in your local country where you reside.

• Double Taxation Risks: Without a tax treaty in place, you might face double taxation—paying taxes on the same income in both your home country and the US if your LLC operates in both jurisdictions.
• Foreign Income Reporting: Many countries require residents to report foreign income and, in some cases, foreign bank accounts.
• Varying Tax Laws: Each country has its own tax rules for foreign income. For some, it’s considered foreign-sourced if you perform the work overseas, and others it’s considered foreign-sourced if the client is based overseas.

4. Ongoing Admin Tasks

Managing a foreign-owned US LLC involves admin upkeep to ensure it remains in good standing with state and federal authorities. This includes not only the annual reporting requirements but also other ongoing tasks.

• Annual Filings and Fees: You’ll need to file annual reports with the state where your LLC is registered. Many states require annual renewal fees to keep the LLC active. Each state has a different fee structure.
• Registered Agent: A foreign-owned LLC must have a registered agent in the US—this is usually a company physically located in the state where the LLC is registered. Your agent will accept and lodge legal documents on behalf of your business.
• State Compliance: Some states have additional compliance requirements, such as annual statements or specific declarations for foreign-owned entities.

5. Insurance

You’ll want to check if you need insurance for your US LLC and what is covered. The coverage may differ depending on if you’re an employee or contractor of your US LLC. If you work internationally or have clients internationally, this can complicate things further and it’s worth talking with an investment broker to see if you need insurance for your industry.

Maintaining a foreign-owned LLC can be stressful for some people, especially with multiple filings, state-specific requirements, and ongoing fees.

If you’re an Australian digital nomad or expat, setting up a US LLC may be a great solution for you. For the most part, it’s simple, flexible, and offers liability protection.

There are some administrative responsibilities regarding annual filings. If you plan to operate internationally without a US presence, a US LLC can be a great options for managing your business, receiving payments through Stripe, and protecting your assets.

Plus, if you move countries, you can take your LLC with you!

Want To Know More?

Here at Adventure Tax, we specialise in providing international tax solutions to Australian expats and digital nomads. Navigating tax-residency and overseas taxes can be complicated and stressful. We’re here to make it easier. To find out more, send us an email or book a call with our team.

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