Developing markets are typically going through rapid change, which can create
a number of tax-related issues for investing companies to manage.
“First, a lot of emerging markets have new tax systems and how they are
applied or interpreted is not always clear, and there may not always be
consistent application,” says Mark Schofield, an international tax partner at
“Second, the tax authorities are relatively unsophisticated and have little
experience of complex deals – and international deals tend to be more complex.”
In addition, double-taxation treaties with developing countries tend to be less
developed, if they exist at all. There is no tax treaty between the UK and
Brazil, for example.
Another challenge is that there may be a multitude of taxes and levies – far
more than UK companies are used to.
“Brazil has 68 different taxes and contributions,” Schofield says. “Most of
these are paid by companies. Emerging markets also often have different
reporting cycles. There won’t just be an annual tax return; you often have to
submit a return on a more regular basis.”
Tax rates, particularly for indirect taxes, can also change rapidly.
Finally, the tax rules can be entirely different from those at home. “China
has no concept of a capital gains group,” Schofield says. “Brazil has no concept
of tax pooling, so you can’t surrender tax losses between different legal
entities in the same group.”
Companies dipping their toe into emerging markets for the first time may also
fail to realise the repercussions of sending out UK-based staff for short,
perhaps repeated, exploratory visits.
“Nobody in the company takes notice of the fact that these people are crating
a tax presence for themselves,” says Andy Hodge, head of Deloitte’s employer
solutions practice. “Going back 10 years or so, most tax authorities took a
pretty relaxed attitude, even if people were going out for 30 or 60 or 90 days.
Now even the most unsophisticated authorities are aware there could be tax due.
It’s also an opportunity to go after companies for interest and penalties – and
they could go back a few years.”
While there are plenty of tax challenges, there are also plenty of good
tax-related opportunities related to emerging markets. For example, developing
countries may offer attractive financial incentives to tempt foreign businesses
“In some regions in China it is possible for any overseas entity to locate
and have a corporation tax holiday,” says Mike Linter, a tax partner at KPMG.
Making the most of any tax incentives is worthwhile. Linter recalls how one
client discovered that setting up a China operation in Shenzhen’s special export
zone exempted it from the export charge of 4% of turnover incurred in Shenzhen’s
The advantage of setting up inside the export zone is obvious, although there
is no guarantee as to how long the exemption will last. China reviews its tax
regime, including its tax treaty with the UK, in 2007.
Linter was also struck when visiting China by the amount of bureaucracy. “We
had meetings with corporation tax people, income tax people, VAT people – all
uniformed party officials,” he says. “Each meeting seemed to be attended by
roomfuls of people.” Regions also seem to have considerable autonomy in
determining tax policies.
Once a decision is made to invest in a location, there are tax issues to
consider in structuring the deal. For example, if the company borrows to fund a
local acquisition, the developing country may have strict rules controlling the
interest that can be deducted before calculating taxable profits, or the debt
may need to be with a registered bank in the territory.
Even moving cash around an emerging market may incur tax costs. Brazil
applies a tax called CPMF at a rate of 0.38% every time funds are withdrawn from
a bank account.
Tax issues also affect the ongoing management of operations in emerging
markets. Aware that many overseas investors will want to repatriate profits,
many developing countries levy high rates of withholding tax.
“They can also be more aggressive in terms of scope of the withholding tax,”
says David Nickson, a partner at Ernst & Young. For example, in addition to
dividends, interest and royalty fees, charges may be made for management or
technical support services.
Schofield also notes that some countries operate “alternative minimum tax”
regimes, whereby a certain amount of tax will be charged, but credit for the tax
will not necessarily be given when profits are repatriated.
With tax, as with all other aspects of doing business in a foreign territory,
it is vital to consider and understand cultural niceties. “In some parts of the
world, tax isn’t necessarily viewed as a cost to be controlled,” says Nickson.
“Paying tax can be about being a good citizen.” This can lead to a culture clash
between an investing company and local tax authorities.
“Similarly, developing areas may take routine compliance on things like
customs duties extremely seriously,” Nickson says. “Even a minor compliance
error could result in the authorities shutting down your operations. It’s
important to establish local relationships. It’s important for a manager who has
gone out to set up local operations to understand the local importance of tax
compliance. You hear stories of local tax authorities turning up on the
manager’s door looking to arrest them, so you need to make sure that your
management is protected.”
Schofield also highlights the need to take compliance seriously. In Russia,
for example, expats who incorrectly declare the number of days they have spent
in the territory are committing a criminal offence, which can, and in some cases
does, result in a jail term. “There are quite stringent penalties,” Schofield
The issue of how to incentivise local managers may also need attention. “How
do you motivate and retain people and get the best out of them going forward,
when they have been taken over by a foreign company?” asks Schofield. “How do
you adjust your share ownership plan to the new market so that colleagues there
can participate in it?”
The tax needs of expat managers also need to be addressed. “You may be
resourcing an investment from the UK with highly paid executives,” Nickson says.
“You don’t want them distracted from the job they are there to do. Personal tax
issues can create all sorts of problems. You need to look at the ramifications:
what they will have to pay in additional taxes, and to consider making
Stock option shock
One blind spot some UK companies have when considering their expats’ tax
situation relates to stock options. As Hodge explains, expats on secondment for
a few years may exercise options during that time but forget they need to
declare this. “Sooner or later it comes out – perhaps because the company gets
audited by the authorities,” Hodge says. “If companies get it wrong, the tax
authorities can go after them for penalties.”
In general, Nickson stresses the importance of getting sound local advice on
tax issues. “It’s very important to get people who are fully immersed in the
local culture and can also understand the needs of investing groups coming from
Europe,” he says. “It’s important that your expectations are understood by your
adviser. There is a limited number of people who are really skilled in
understanding the needs of the investing group as well as the local culture.”
Box: The biggest tax blunders
- Not understanding what it is you are buying, how the valuation assumptions
are made and how the profits will be repatriated.
- Making assumptions about how an emerging market’s tax system works – and
then not testing those assumptions.
- Failure to devote sufficient time and effort at the outset to getting the
investment decision and the structural implementation right.
- Failure to appreciate the importance of the tax penalty regime in the
emerging market and its potential to affect your investment.
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