Proprietary Limited Company
It isn’t just US tax residents working abroad as employees who have tax implications in the US. Those US tax residents who hold companies have lots of tax rules to wade through before they can achieve the right US tax result. Seth, based in Sydney, Australia, and Khandra, based in Melbourne, Australia, talk about the implications you can expect if the company you’re involved in is a proprietary limited company. We also recommend that you watch our self-employed video when considering this area and deciding what’s best for your circumstances.
What is a proprietary limited company?
A proprietary limited company (“Pty Ltd”) is a form of privately held company in Australia, with at least one shareholder and no more than 50 non-employee shareholders. It’s by far the most common type of company that we see here. One of its attractive features is that the liability of the shareholders is limited to the value of their shares, so their personal assets are not at risk. This offers shareholders more protection when looking at things like company debts. However, setting up a Pty Ltd company should only be done after careful consideration of the impact on your US tax return.
Do I have to include my Pty Ltd company in my return?
Quite probably, yes. Pretty much everything ends up being reported on your US tax return. Initially the key thing to look at is whether you own 10% or more of the Pty Ltd company. If you do, there will be some sort of paperwork to file with the IRS. The complexity increases the more shareholding you have. If you control the company – that is, owning 50% or more, the calculation of which can itself be complex – then it falls into the Controlled Foreign Corporation (“CFC”) rules in the US. In such cases, you are required to file form 5471 (a way of reporting certain foreign corporations for which the US tax resident is an officer, director, or shareholder) and form 8858.
This sounds bad for my US tax – is it?!
Not necessarily. Tax reform in 2017 gave some clarification for US tax residents who find themselves in this position. In our experience, we’ve often found that we’re not looking at a bad a tax result due to the Pty Ltd. However, it does result in more forms to file and more complexity. You really do need advice when you own 10% or more of a Pty Ltd company.
How does owning a proprietary limited company affect a US tax return?
Having a Pty Ltd company adds another layer of complexity to a US tax resident’s US tax return. There are strict rules affecting the level of tax you may need to pay in the US as a result of having a Pty Ltd company.
So, what do we need to make sure the rules are complied with where a US tax resident has a Pty Ltd company?
To properly complete form 5471 we, as your tax professionals, need similar documents to those that the self-employed are required to provide. The essential list is the following:
- A complete set of financial statements on a calendar year basis (profit and loss, balance sheet, etc.).
- Your Australian Pty Ltd company tax return.
- Information regarding the share registry, who the owners of the company are, whether they are US tax residents, and how they relate to you.
All this information helps us analyse the accounts up front to determine how best to approach your US tax return.
What’s the position if your Pty Ltd company in Australia makes a profit?
The rules have changed so much in this regard. If you’d asked us this even just years ago, back in 2018, the answer would have been very different. Back then, the ‘GILTI’ regime was very much in force and wreaking havoc for many small businesses making a profit. The current situation remains that the US regime is intended to deter US tax residents from setting up foreign businesses; there remain traps. However, the recent IRS guidance has provided further clarification, which has helped hugely. In essence, if you live in a country whose corporate tax rate is higher than the US tax rate, then you can take some benefits from that when preparing your US tax return. The effect of this in Australia is that those US tax residents paying Australian corporate taxes are seeing much brighter outcomes on their US tax return.
We mentioned, however, the traps. We’ve talked about active businesses, but there are also those US tax residents who are using foreign corporations to hold investment assets: stocks and shares. This brings with it a whole different tax regime, and one that can have nasty consequences for the US taxpayer. There are, however, a lot of different outcomes, all based on an individual’s own facts and circumstances. In terms of the end result – what you pay to the IRS – we find that with proper tax planning and appropriate use of the complex tax rules and regulations, we can make sure you achieve the best outcome possible, although it’s right to say that there are individuals who will end up having to pay some level of US tax.
What’s the summary?
- Make sure your advisers properly understand the US tax regime.
- Carefully consider with your advisers the most advantageous ways of setting up a new company or sharing assets.
- Once a company has been set up, make sure information sharing is done effectively between your advisers.
Can a US tax resident get around the reporting rules by putting 91% of the company shares in a non-US (for example, Australian) spouse’s name, so that the US tax resident holds only 9%?
Unfortunately, it’s not that easy. This scenario effectively imagines a US tax resident with a limited company in Australia using their Australian spouse to avoid the potential tax implications of holding a Pty Ltd company. The IRS has perfected the art of anti-deferral and anti-avoidance regimes, which address situations like the example here. There are complicated rules around constructive ownership and attribution, as well as rules with respect to the family members of business owners in general; it’s not just spouses that are targeted in the anti-avoidance regimes, it can be parents and grandparents, too! This all goes into the analysis of what you have in Australia and what it means for the US tax return. There aren’t lots of easy ways out.
Is this also the case where the non-US spouse is the sole shareholder and the US tax resident is classed as an employee only?
The IRS has also tried to find ways of making that type of asset planning difficult. However, there has recently been more clarification from the IRS, which shows that this sort of planning remains a valid and useful tool. We can therefore give careful consideration to the most suitable way of attributing assets. That said, the rules around reporting these types of entities aren’t going to go away anytime soon, and won’t get any easier. In fact, the rules seem to be getting more complex as the IRS tries to address these sorts of eventualities.
Are the new regimes and associated guidance here to stay?
Currently those in Australia do benefit from having a business in a higher tax jurisdiction (the corporate tax rate in Australia typically being 27.5% – 30%, in contrast to the US’s 21% rate). The guidance and regimes that we’ve spoken about help us achieve the best outcomes. However, US tax residents can’t become complacent. The real question is how long the US rules will remain as they are (for example, their corporate tax rate). The US now has a new presidential regime. In addition to that, some existing rules are time dependent, likely to expire in 2025. As a result, it is very much a case of having to watch this space. It is quite possible that the whole tax regime will change dramatically over the next few years.
What do you really need to be doing?
You need a tax professional who understands both the Australian and US tax regimes. When both regimes are properly understood, your tax professionals can work together to get the best results for your individual circumstances. Of course, each regime has its own complexities, but the US side is so unique that a sufficiently in-depth knowledge of the impact of US citizenship is essential. Even getting a tiny piece of the puzzle wrong can have huge implications for a US tax resident.
In our experience, we find the best way of achieving positive outcomes is by communicating directly with Australian tax professionals. This takes away some of the stresses for US tax residents, by making the whole process that bit smoother. When we get involved, it means that the back and forth between tax advisers doesn’t necessarily need to be really extensive, with overly time-consuming discussions with our Australian counterparts.