<Update> Dec 2012:
So, it looks like Christmas has come early. As mentioned in my April update below, the SSN barrier has been impossible to overcome. Until now. Thankfully, the legends at Stripe (Disclosure – AffinityLive pays them a lot of money, they don’t know we exist) have changed things – as long as you have a US bank account, you can enter 0000 as your last 4 digits of your SSN and get an operating account! I strongly recommend my friends at Silicon Valley Bank to set up your account with them – NOTE that you don’t need to have an LLC or a C-Corp to open an account with SVB.
<Update> April 2012:
It is impossible to get a merchant account and accept payments in US Dollars without a Social Security Number (SSN). I’m not 100% sure if this is because of issues around the Patriot Act (no sending money to Iran or Korea, or remaining axes of evil), general money laundering, or because the back-end providers (I’m told there’s really only a couple of them who handle everything in the US) require it and every bank and gateway as to play by their rules.
I know this sounds silly, since a company doesn’t have a social security number (only people with the right to work in the US can get one), but it is just the way it is.
At this point, you’ve basically got four choices:
- Use PayPal (where the customer leaves your site) and accept their credit card in US dollars. You’ll get a horrible exchange rate and a pretty poor user experience.
- Go with a “reseller” and pay a high commission fee. I looked into FastSpring at the time.
- Find someone who trusts you and use their SSN to open an account with someone like Stripe, or
- Move to the US on an E-3 Visa and get a Social Security Number yourself.
Sorry I don’t have better news.
Running an Australian business with Australian customers is great – you can get trading with an ABN in minutes, and while the GST caused us all a lot of grief a decade ago, it now enforces a fairly simple discipline that keeps your business in check. Hell, if they’d just get rid of payroll tax that creates an incentive to move jobs offshore, and insist that corrupt union reps have a ‘fiduciary’ duty to look after their best interests of their members rather than their own political careers, we’d be set.
Unfortunately, though, running an Australian business in a global market sucks. A lot.
This post tries to outline an approach to setting up your Australian internet business so that you can trade on close to a global market scale, competitively. And that means being able to price your product in US Dollars, and get paid in US Dollars, without getting completely screwed by transaction, currency exchange and lots of other fees.
This post is a work in progress, and will be updated as better advice and the pain of real world experience corrects assumptions/guesses. If you’ve got something to ask or contribute, please do so in the comments.
Getting Paid in USD
When it comes to the global marketplace – particularly online – the only game in town is US Dollars. A big chunk of the market is in the United States, people who aren’t are largely aware of how to convert from USD into their own currency, and most importantly of all, when prospective customers are comparing offerings and prices, they’ll be benchmarking your offering against your competitors, who’ll be pricing in USD.
If prospective have to think and convert your currency of choice into USD for comparisons and then their own currency for the cost to them, they’re probably going to have to reject you.
So, you need to get paid in USD if you’re selling online to a global market.
There are roughly four ways I’ve found to get paid online in USD as an Australian.
- Use a US Gateway and set up a US entity
This method means getting a business, a bank account and a tax identification number set up in the US. It involves cost, paperwork and dealing with the IRS. However, it also means you can access very competitive pricing from gateways – the people who link your website to the credit card payment networks and thus get money into your account. A couple I’ve found – Cocard and Authorize.net in combination – are going to cost me US$18/month and their fee is only 0.15% above the credit card company interchange rate. Pretty compelling, but now your business has two bank accounts, two legal entities and two currencies to do accounting for, not to mention the risk of double taxation and other inter-government scams.
- Use a European Gateway and set up an EU entity
The next option I’ve come across still involves creating an entity, but in this case it is more of a piece of paper entity. No bank account, no legal structure, no double accounting. As far as I can tell, you pay a small fee to someone like simpleformations.com, and then you find a company who’ll give you a merchant account such as www.nochex.com who can take credit cards, and they’ll deposit the funds as a wire transfer into your Australian account.
Unfortunately, all the options I have prices for at the moment have a minimum monthly transaction of A$3000 or so.
- Use an Australian Gateway who supports multiple currencies
As far as I’m aware, the only option open to Australian businesses who want a merchant account that supports multiple currencies is the National Australia Bank. I’ve made an enquiry to find out what the current state of affairs is on this, everyone I’ve talked to who’s tried this has had a terrible experience. A search for “nab merchant account rant” on Google turns up gems like this and this. I’ll update this post if this option surprises me and becomes even remotely competitive, but I’m not holding out much hope.
- Use a US ‘Reseller’ style company to collect credit card payments on your behalf
This option is lowest setup effort, but it also provides less control, is least professional for users and costs the most in transaction fees. Companies like Plimus or Fastspring are effectively becoming our retail or reseller front end, reselling our product, and so all client interactions and payments go through these companies. They also charge up to 10% for their effort (and risk taking) getting between you and your customer, which while compared to traditional retailing and channel’s isn’t crazy, but they’re not actually finding you customers and handling client support the way a regular retailer or reseller would; 10% for payment processing is very high. If you’re only doing small amounts of revenue, this might work, but if you’re trying to build a business that is more than a hobby, this is a stretch.
Having reviewed a bunch of the crappy options, the direction I’m leaning towards is setting up a US entity, opening a bank account, and getting a tax identification number.
Having a US entity, bank account and tax identification number
The idea of this post is to save future Aussie entrepreneurs some of the hassle/drama/uncertainty associated with doing business globally. If you’ve got any knowledge of any of this stuff and could affirm or correct any of these assessments, I’d really love to hear from you in the comments or by emailing geoff.mcqueen – at – hiivesystems DOT com!
The following is what I’ve worked out through a bunch of research, a couple of hours on the phone talking to staff in the IRS, and reading ATO Tax Rulings.
While I recognise that spending hours on this while we’re trying to get AffinityLive ready for launch is a bit stupid – this is what you pay accounts for, right? – I’ve found in business that understanding the fundamentals of these sorts of things yourself is priceless – after all, as a Director, it is me, not an adviser, who’s on the hook. Additionally, whether it is in IP law or other areas, understanding the basics means I’m in a better position to assess whether one adviser or another is more expert, and thus make the best decision about who to go with.
Business registration in the US is handled on a state by state basis. One of the most appealing states for registering your business is Delaware – their fees are low, they have no sales tax (whereas in California it is close to 20% and the state is still almost bankrupt), they don’t take to kindly to people suing company officers and they are “friendly” like the Swiss when it comes to confidentiality. Handy.
There are a bunch of different entity types you can register in Delaware. The most common types as far as I can tell are a C-Corp and an LLC.
A C-Corp is like an Australian Limited company. Note that it isn’t equivalent to a Proprietary Limited (Pty Ltd) company, as a C-Corp has to have officers, needs to file returns to the state, and a bunch of other stuff. Nothing too scary, but more formal than you’d be used to if you’re running your own Pty Ltd company.
The company can file its own tax returns with the IRS (Federal, not state).
A C-Corp can keep hold of its own money from a tax perspective, paying dividends only when it wants to. It also doesn’t have limits on the number of shareholders like some of the other structures, so it is a good type to use if you’re looking to raise a round of capital by selling equity to investors. This entity is pretty much what you’re used to with running an Australian company, but having a C-Corp makes the repatriation of funds to Australia a bit more interesting, and makes transfer pricing a potential issue, as the C-Corp is a full company, and your Australian parent operation may well be a shareholder – or the only shareholder – but the IRS will treat the C-Corp as its own entity.
A Limited Liability Company (LLC)
An LLC is a particularly curious beast. It is like a company in that the business shields the owners and officers from personal liability should the business fail and have debts. It can have a bank account and trade just like a regular business. However, it can’t submit its own tax return like a company and pay tax – instead, the profit that the business makes flows through to its “members” (like shareholders), and they pay tax on it just like it was any other form of income.
In this sense, an LLC is much like an Australian Trust structure. And the way the Australian Taxation Office treats these LLCs – also known as “hybrid vehicles” because they tend to be more like a partnership where the “members” or shareholders can be natural persons and companies – is pretty good from what I’ve read so far. More on that later.
Regardless of the structure you follow, registering the company in Delaware is fairly inexpensive; there are a ton of agents out there who’s job it is to do just this sort of thing.
Just one example is IncNow.com, and the cost of registering an LLC and being up and running within a week is under US$300.
Annual fees are in the range of US$120 – also fairly reasonable at $10/month.
You also get the forms you need to submit an application for an Tax Identification Number (TIN), which your merchant account people will need you to have to set up your account with them.
Franchise & State Taxes
In Delaware, they make their money by charging a small “Franchise tax”. From my reading, this would be around $90/annum. Bugger all really.
IRS and Federal Taxes
While business setup in the US is a matter for the state jurisdictions, it is the Federal Government you really need to worry about. Like in Australia with the ATO, the IRS are very bureaucratic and hungry for your money.
Every year, they require all taxpayers in the US to pay income tax and file a tax return – this includes not just individuals, but also companies, members of LLCs, etc.
If you’ve got an entity and a bank account, odds are that means you too. I’ll outline a bit more of what I understand the alternatives and situation to be in the Tax Returns section below.
Australian Taxes, Dividends and Double Taxation
Of course, if you’re running your company/business from Australia, you’ll have your regular dealings with the ATO to worry about too. This in and of itself isn’t a problem, but bringing together multiple tax jurisdictions around your taxable profits is asking for trouble – if someone’s going to get f*cked, it is going to be you.
Tax returns and not getting double-screwed
While there are undoubtedly a bunch of issues to address with running an international business and dealing with governments, the one that I’m trying to get to the bottom of with this post is tax.
Basically, I don’t want to be paying tax on the same income twice, and where possible, I want to be paying the lowest rate of tax I can on hard-earned profits.
Everything from here on in is assuming we’re running the US operation through a Delaware LLC, with a bank account in the US, and credit card based income coming into this US bank account.
There will be a few thousand dollars a month – initially – of expenses in US Dollars, mostly things like hosting fees with our US hosting provider, and a few odds and ends like local US phone numbers and such. All other expenses – our rent, our staff costs for product development and client support – will all be in Australia and paid in Australian dollars.
All income for our AffinityLive.com product sold to clients outside Australia will come through this LLC, with clients paying recurring monthly, quarterly or annual subscriptions in the hundreds of dollars via credit cards per client.
As a result, it is expected that the US entity will be quite profitable compared to the Aussie HQ given its lower fixed costs.
Complying with the IRS
As far as I can tell, running an LLC means that you’ve got two choices – the LLC can submit its own tax return acting as a corporation – a 1120 form – or its “members” can submit tax returns for their own share of the income that is distributed from the LLC.
To simplify things, we’re currently planning on completing our US tax return using a an 1120-F form, which is what a foreign company completes to declare income earned through their business activities in the US.
The IRS agent I spoke to today told me that we’re effectively declaring the income as Australian company income, earned through US business activities, and the LLC in this case is a financially transparent entity that doesn’t complete its own tax return.
If you submit a corporate tax return as the LLC, you’ll be taxed on your profits the normal way; I think it is around 33% or so. Then, you can repatriate your after-tax income to Australia, and the IRS is pretty much done with you.
The standard tax year in the US is a calendar year; again, to simplify things, we’re going to complete an 1128 form to move our tax year to be July to June and thus in-sync with our Australian financial year.
In some situations – and I don’t quite understand thesem but they seem mostly related to property transactions? – the IRS will also withhold a percentage of your dividend on top of the tax they’ve already collected.
One of the reasons to go with an LLC over a C-Corp and to use the 1120-F form, completed as the Australian parent, is to avoid dealing with dividends and transfer pricing issues at all, so hopefully withholding won’t be an issue for us.
Foreign Tax Credit
Australia has a tax treaty with the United States, which means income earned in the US is taxed by the US, and once it is repatriated to Australia, you get a credit from the ATO for the tax you’ve paid.
In a way it isn’t quite this easy, as the ATO will actually “gross up” your dividend to put the amount the IRS took away from you back on, at which point the ATO will calculate the amount of tax payable as if it was all Australian money, and then it will credit you for the amount you paid to the IRS on the US income, and you’ll then owe the ATO whatever extra tax they say you owe them. I think this is there so that ATO gets to charge you Australia’s tax rate and get more money out of you for income earned in places with lower company tax. What I don’t know is whether the reverse applies, and the ATO will allow us to “deduct” all of US tax from our total tax payable (since the US rate is a bit higher), or whether the ATO will have it both ways – charging you more tax when the other country has a lower rate, and saying bad luck and quarantining foreign income and tax when there is a higher international rate.
No Franking Credits on US post-tax earnings
When a company declares a dividend and pays its shareholders, the shareholders need to account for that income as part of their normal tax return process, and pay tax on that income at their marginal tax rate. In Australia, a concept known as Franking Credits means that Australian taxpayers don’t have to pay tax on the whole amount of the dividend, since the dividend has already had company tax come out of it. It is a fair and great system, but unfortunately, the dividends that come as a result of internationally taxed income don’t get franking credits.
The following example, courtesy of a great newsletter from the team at Johnston Rorke, shows how you could lose almost two thirds of your hard earned profits to taxes due to this lack of franking credits. In the example, a foreign company makes a $1000 profit, the company tax rate in the foreign market is 35%, and the personal tax rate for shareholders in the Australian parent company is assume to be 40%. They’ve also included a dividend withholding tax rate.
As you can see, even allowing for the Foreign Tax Credit (note the “Nil” as the tax payable in the Australian company), the fact the shareholders have to pay tax at their full marginal tax rate (no dividend franking) means the effective tax rate on the end shareholders is a horrible 64.9%.
Things Still to Work Out
There’s still a lot of questions in the above.
I currently don’t have a good handle on exactly how the ATO will treat the income that comes via the LLC, as it is what the ATO calls a Hybrid Vehicle. While it would appear that the ATO will recognise the tax credit, I want to know for sure that this is the case, and unfortunately for me, researching this information on the web is pretty tricky, as the ATO has been making changes in the last couple of months – see http://law.ato.gov.au/atolaw/view.htm?docid=”AID/AID201077/00001″ for information that at the time of writing this post, was less than 3 months old.
I also want to understand the C-Corp scenario a bit better – particularly the dividend withholding issues – in case we find for legal or investor reasons we need to step up from an LLC to a C-Corp.
Another thing to look into is the option of setting up a structure in a tax friendly third country. Capital Gains tax in Australia is particularly horrible for entrepreneurs; not only do we have profits and incomes taxed, but if we manage to sell a company we’ve spent tens of thousands of hours and much personal risk building over many years, the tax man then wants to tax the money you get from selling the company at the top marginal tax rate in the year you sell it, in effect taking half of your pay off for success as tax. Other countries like Hong Kong and Singapore don’t have similar capital gains tax situations, however, since all the IP is currently owned by an Australian based company, and changes would need to be very well thought through as moving the holding company to another country would be expensive because it would trigger a capital gains tax event at the time of moving (since a company you set up in, say, Singapore, would be buying the Australian company, and the ATO would tax the shareholders – you – on that transaction even though no real money changed hands).
If you have any knowledge of how this is treated through first hand experience, or can point to an online article that explains it a bit more clearly than the ATO website tax rulings, I’d really appreciate you leaving a note in the comments.