With South Africa’s tax season underway and SARS’ auto-assessments being sent out, the tax revenue service has warned of scams targeting eFiling users. SARS…
You’re a South African and want to set up an offshore company — but a business has so many functions. There’s the finance department, the sales unit, the product development division and countless other functions. Which of these should you allocate to your planned overseas company?
In this, my third article in this series aimed at clients who are building an international business structure (see the first here and second here), I will talk about allocating the functions and operations across each company in your group – bearing in mind that your goal is that of building value offshore.
Start by identifying each logical, functional part of your business: product development, sales and marketing, finance functions, etc. The idea is to allocate that function to one of the companies in your group (ie either to an onshore or offshore company).
This is crucial, because in order to anchor your company’s value in a specific country, you need to allocate the associated function to that company.
This is most important when it comes to choosing the company in the group that will be the guiding mind, the creator of strategy, which will define how each function fits into the vision of the business.
As a SA startup looking to expand internationally, how do you allocate functions to your overseas company?
That company (the decision making and strategy-creating entity) will be where the essential substance of the company is – and typically, that is where the intended tax residence is, as well as the location of the intellectual property (IP) developed by the group.
Here is an example of a “functional analysis” of a simple, conceptual group:
● Operational company: This company will have the function of employing most of the operations and development personnel. For example, if you are developing software, this company will employ your software developers and management staff. Given that South African is a wonderful country to live in, your staff are likely to want to live here and so they usually chose this company to be in South Africa. Let’s call this one SACo.
● IP holding company: This company will have the function of owning and holding the intellectual property (IP) developed by any other company in your “group”. It will also be the most valuable company in the group, and it is where all the strategic decisions and other important functions are performed. Yes, this is the one you want to look after very carefully, because this is what Google or Amazon or the like will want to buy. Many entrepreneurs want this one to be offshore. So, let’s call this one OffshoreCo.
● Sales company: This company will have the function of selling your product and service to customers globally and receiving revenue in return for this. You don’t always have a separate company for this. In fact I recommend that, for startups, you bundle this role into OffshoreCo — this just reduces the costs and administration hassle. You can always create a separate sales company later.
What’s next? Well, now you need to formalise each company’s functions. Let’s start at the top:
● OffshoreCo: This company will need to have relationships with the other companies in terms of the services (“functions”) provided by them to OffshoreCo. By legally formalising these relationships, you can channel the group value up and away from those subsidiary companies, to OffshoreCo. The other companies become service providers, and OffshoreCo becomes the obvious place of true corporate value. Remember, this is the company that may receive investment or even be sold. However, over and above that, you should put in place a clear decision making structures in terms of which the group is governed by OffshoreCo. This needs to address everything from board meetings, budget decisions, risk or reward investment, performance managing the service providers, strategy development and implementing that strategy through OffshoreCo’s employees and across the group.
● SACo: This company will usually have defined operational roles, which are delivered to OffshoreCo, or on its behalf. For example, if SACo is providing development services, this development service agreement should specify the services, their value, how they will be charged for, and how they will be measured. Good practice requires that this agreement should be on the same terms as if SACo and OffshoreCo were unrelated companies, contracting on an “arms-length” basis. Indeed, the fees by OffshoreCo to SACo should be arms-length so that SACo is fairly paid for the value which it creates in South Africa. The SA Reserve Bank will be very concerned whether SACo is being paid enough, in return for its services. That is to ensure that enough tax reaches the fiscus. So, SACo will need to explain the reason for invoicing OffshoreCo, and also how the fee is calculated.
● Sales functions (OffshoreCo): Here you put in place the selling machine. It may be as simple as OffshoreCo’s online terms, but it could also be made up of a team of international, roving sales people negotiating complex license or service or supply contracts. The idea is for all non-SA sales to be allocated to OffshoreCo, however, if SACo is also selling (to SA customers) then SACo will need to be appointed and paid accordingly (again, transfer pricing considerations will come into play).
Adrian Dommisse has extensive experience in corporate and financial transactions across Africa, Europe, Eastern Europe, and the Middle East. He founded Dommisse Attorneys law firm in 2008, and holds three degrees in economics and law.
Featured image: Free-Photo via Pixabay