Plugdin Insights: The rise of the micro-national
Plugdin Insights: The rise of the micro-national
The term micro-multinational has come to the fore in the past 18 months, as businesses of all scales seek to transcend their home markets in a time of globalisation. The traditional route of building a business to scale before expanding into overseas markets has been turned on its head in recent years, with tech scale up businesses taking advantage of technological advancements to explore new regions.
Here we look at the rise of the micro-multinational with BDO’s Tax Director for the tech and media sector, Vinesh Bharadwa, to understand their place in the business world and what the future may mean for them…
What are “micro-multinationals”?
Micro-multinationals are SMEs taking advantage of the latest technological innovation to extend their reach internationally, expanding globally early in their business lifecycle. By taking the plunge earlier, supported by cloud-based services and SaaS solutions, scale-up businesses can make a leap without needing remote infrastructure in place.
A traditional business would start by growing in the local markets before moving to international growth. However, tech and media services are typically selling digital products that can be sold through the cloud or the internet, meaning they can grow in local and global markets concurrently. Considering that 99% of all businesses in the UK alone were SMEs (5.7 million as of 2018), it is logical that these businesses are pushing the boundaries of what’s expected for a multinational business.
The micro-multinational trend
The benefits of being a micro-multinational are that companies can explore a market without having to invest the significant capital that would normally be required, and that the business does not need to have established an office or full-scale team abroad to enter a market.
Start-up and scale-up businesses can benefit from this style of operating internationally. Being relatively small means businesses can be nimble and innovative, and therefore can be much more impactful than large international rivals; companies can find niches and gaps in the market globally.
The ease by which a company can set up a remote office is also a draw for SMEs looking to test the waters of a new market. Setting up a foreign office is relatively straightforward now, as there are many coworking facilities, such as those run by WeWork, around the world that offer serviced office space. Businesses can create infrastructure relatively quickly, without having to do the hard work themselves. Rather than establishing fixed office premises, SMEs can find a few key employees to initially float their company service or product, without risking large investments into larger new teams and office space.
The potential revenue stream that a foreign market could provide is invaluable. There’s a reason why total UK exports of services rose to £162.1 billion in 2018, an increase of 13.7% from 2016; it pays to trade internationally.
The reputation of a business in its country of origin could also be boosted by the entrance into a new market. Particularly with technology businesses, often the aim is to become the first provider of a service or a product in a territory, in order to gain a competitive edge or to be “the first” from a brand awareness perspective. Expanding internationally can be transformative in terms of brand image and as a result micro-multinationals can quickly build up a portfolio of large global customers.
What are the typical challenges for micro-multinationals?
"Moving into a new market can be very lucrative, but with greater earning potential comes greater risk of accidentally flouting tax law or running into difficulties with operations. Though the micro-multinational can move swiftly into a new market, it is critical to be aware of the potential implications, especially from a tax perspective."
Having people on the ground in a country could create a taxable presence in one territory, but not require registration for all taxes in another, due to the nature of activities undertaken locally, differing local rules and the impact of tax treaties on the creation of a permanent establishment. The key issue that BDO typically sees with clients is that tax rules differ significantly across territories. There's an assumption that if a business provides a service in the UK, then they can offer it in exactly the same way across the world with the same tax outcome. However, all territories’ rules and regulations are completely different. For example, the US operates a multi-layer corporate tax system at federal, state and local levels and having customers in multiple states is likely to result in tax administration complexities, which could mean paying tax to more than 50 different US tax authorities.
A tax presence – and the form it takes – can be problematic even from a revenue point of view. If a business has overseas customers, and it receives income from them in their local region, tax may still be levied in that foreign territory in the form of withholding tax depending upon the nature of payments being made. The local businesses may deduct such taxes even when not entitled to do so in order to minimise their own risks. Such taxes may then not be entirely (or at all) deductible in the UK against the home country tax liability.
However, the issues that tax could present may be mitigated, depending on the structure and activities undertaken in a foreign jurisdiction. Tax treaties the new location has with the business’ country of origin should be considered. It is important to consider these matters at the contract negotiation stage to avoid withholding taxes being an actual cost to the business.
The impact of transfer pricing in relation to transactions between group companies should also be considered at an early stage to ensure such transactions are reflected at arm’s length prices. If an inappropriate transfer pricing policy is applied it could mean profits being overstated in high tax territories, like the USA, Germany and Australia resulting in tax leakage across the group. Many UK companies will not have given this much consideration prior to expanding internationally as the UK has a transfer pricing exemption for SMEs, but most overseas territories do not have such exemptions and so having a transfer pricing policy and supporting documentation is key to avoid falling foul of tax authorities.
Having globally mobile employees can also pose tax challenges, employment tax liabilities arising in multiple countries need to be managed and correctly administered to avoid employees suffering excessive tax, which will have an impact on their take home pay. There are also numerous layers of red tape such as short term business visitor reporting and compliance.
It’s not only the tax issues that can cause headaches for SMEs looking to move into a new country. Language and other cultural barriers, and the difficulty of finding the right people to get a new business branch established, can cause unnecessary strain when getting set up.
Some 74% of SMEs surveyed by Radius and CFO in 2015 said they experienced difficulty in controlling their international activity. This difficulty can encompass the regulatory, legal and cultural aspects of a foreign territory, with companies potentially finding issues whilst translating corporate culture, managing a remote office or understanding how a target audience might respond to marketing.
This is further compounded by the fact that micro-multinationals typically have small finance teams relative to their international operations. Managing the global compliance requirements, whilst also having an appreciation of different concepts being applied by different territories can be a significant challenge. It can detract from the focus on expansion if not managed appropriately. Outsourcing all of the requirements can be prohibitively expensive. Knowing what is critical to outsource and having an adviser coordinate internationally is a good compromise.
Are micro-multinationals the future?
There is a move towards making it easier for micro-multinationals to operate globally from a commercial perspective. However, due to the scale of change, global tax authorities are highly focused on how the digital economy should be taxed and how the measurement of recognised profits between countries should be made in a fairer way.
"The encouragement of micro-multinationals will have to start with regulation. Governments globally need to enable trading in a much easier way, to facilitate the growth of the digital economy effectively."
- The ease of global business has resulted in the rise of the micro-multinational, a nimble and innovative structure for new and existing markets.
- Expanding across multiple territories can be lucrative, but can pose a number of challenges for the business, including tax issues. It is advisable to:
- Have an awareness of when a taxable presence is created in an overseas territory;
- Ensure withholding taxes are mitigated at the contract negotiation stage, and do not form a real cost to the business;
- Minimise tax leakage by maintaining an appropriate transfer pricing policy;
- Manage the tax consequences of having globally mobile employees
- It can be a challenge for small management teams to control international activity; from regulatory and legal aspects, to differences in culture and target markets.
- The scale of technological change will make micro-multinationals more common in the future, putting pressure on governments globally to make it easier for companies to transact in the digital economy.