THE EXPERTS' ADVICE:A panel of experts advise Sam Farrelly
Colm O'Callaghan (Senior tax manager, private company services, PwC):THE DECISION to expand internationally needs planning and cautious footwork and, while there are a number of key commercial issues O'Brien and Farrelly should consider, one of their primary objectives should be to ensure they have structured any expansion in a tax-efficient manner.
Regardless of whether O’Brien and Farrelly decide to expand into the North, the UK or Europe, the first question they will need to answer is whether to carry out the expansion through the establishment of a branch of the existing company or form a new foreign subsidiary. This decision is likely to be influenced by whether the expansion is envisaged to be profitable as losses of a branch can be utilised against profits of the Irish company (thereby reducing the tax liability) and therefore a branch may make sense initially if losses are anticipated at the outset.
If profits are expected, they should review what activities will be carried out abroad. Corporate tax rates in Europe are typically higher than Ireland’s 12.5 per cent – therefore it’s important to determine where the profits will arise and it may be possible to attribute significant profit back to Ireland so as to reduce the overall effective tax rate.
In many cases, some degree of finance will be required to expand a business. Some jurisdictions (such as the UK) have thin capitalisation rules that will require a certain amount of equity invested in the company before O’Brien and Farrelly can get a full tax deduction for interest incurred on debt. They will therefore need to ensure that any financing is structured in an efficient manner.
Finally, O’Brien and Farrelly should consider an exit strategy if they decide to leave the foreign market, sell or want to extract funds from the foreign company in the future. Investments abroad should be held by a company in a good holding company location – such as Ireland – which allows them sell without incurring either Irish or foreign capital gains tax, reduce or eliminate the rate of withholding taxes applied to interest and dividends on repatriation and which allows for profits be to be repatriated without incurring unnecessary incremental taxes.
Farrelly is right to be cautious and should plan carefully for the expansion in the most tax effective way, thereby ensuring they get a tax deduction for finance costs, manage their tax rates, have an efficient structure for the repatriation of profits and, on an ongoing basis, ensure that VAT and local employee taxes are correctly operated.
Margaret Hearty (Director of business programmes and services, InterTradeIreland):IN MANY ways, Farrelly is in a very fortunate position. He has a solid business proposition, good performance in his domestic market and a healthy balance sheet to boot. He has tapped into the growing demand for green products and his brand position will play well with the environmentally conscious consumer. That said, he cannot afford to stand still.
I would question the general assumptions he has made on pricing and buying behaviour, particularly in the current climate and in the absence of any actual market research having been undertaken. He really needs to invest the time and effort to get a true understanding of his current and potential customer base and all the factors affecting their purchase decisions. Without this information, he is shooting in the dark.
Farrelly is right not to let excess production capacity alone drive expansion into new markets. However, it strikes me that, since Northern Ireland is his closest export market, this is a natural starting point for growing an export business. He needs to scope the market in the North, spend time in the new marketplace and meet and talk to as many businesses as possible.
He should also investigate the export retail or distribution channels for his products and examine competitors closely including their marketing and promotional tactics. With sterling as the operating currency in Northern Ireland, he should also get as much detail as possible on price points.
He could also engage an experienced local sales or marketing consultant to assemble the facts and figures and give a realistic and impartial assessment of export opportunities in Northern Ireland. InterTradeIreland offers a range of financial supports to help southern small to medium enterprises (SMEs) export to the North, including funding to hire an experienced salesperson based there either on a part- or full-time basis.
One of the concerns raised by O’Brien was the risk of sterling exposure as a result of trading in Northern Ireland, but there a number of options open to him.
He could request payment in euro from retailers so he has less exposure to currency fluctuations. However, he may need to look at the local price points and use the information he has gathered to agree a euro price that will still enable him to be competitive. He could also agree a “forward contract” with his bank which would give him a fixed exchange rate.
In my view, the market in Northern Ireland presents an excellent opportunity for Farrelly to grow his sales and it could offer an invaluable test bed for exporting further afield. Furthermore, there is funding, expert advice and support available to help him which ultimately increase his chances of success.
Liam Fennelly (President of MBA Association of Ireland):THERE'S A positive tension in this company between two men. That said, we do need to see more of the entrepreneur in Farrelly. For someone who took the plunge by quitting his job, he seems a lot happier cocooned in his production department than doing the deals at the coalface. He doesn't seem to have a thirst for expansion and that imbalance can't augur well for a business that needs to grow.
He may be playing to his strengths, but by delegating the commercial function from the outset, he’s also delegating the opportunity to gain insight into the customer and the all-important retail channels. These are the insights he, as owner, needs in order to bring this business forward.
He will face similar dilemmas as the company evolves. I can’t help thinking his distance from the marketplace leaves him ill-equipped to make informed decisions. Farrelly has product knowledge, a promising product pipeline and capacity to expand. What he doesn’t have is knowledge of the European market or its size. Without this, expansion into Europe is a daunting and probably unwise course of action.
The risk trade-off between the UK and the continent is interesting. O’Brien fears currency fluctuations but doesn’t seem to acknowledge the greater threats Europe holds for a small company. Farrelly lacks the resources to break into foreign markets where the multiples’ stranglehold on the retail channels makes entry an arduous path, littered with cultural and logistical obstacles that are new to the company. Engaging agents, and monitoring them, will be a time-consuming role, and certainly not one Farrelly can do from his beloved production floor.
From a resources perspective, using existing distributors to edge his way into the UK sounds a pragmatic course of action. The knowledge they gain in the process will stand them in good stead for future forays into Europe.
In this instance, I’d side with Farrelly’s conservative instincts but he needs to work on those same instincts to ensure future development. Domestic demand will not support growth in the medium term, so export expansion is an imperative and that means bold decisions. Even in these straitened times, it’s the appetite for risk that characterises the successful entrepreneur – and we need to see more of it from Farrelly.
