HMA Bites: Legal Structures Used by Management Companies Expanding Internationally

Welcome to HMA Bites - our regular column in Check-In where we take a look at an issue relating to hotel management agreements ("HMAs") and provide insight, tips and advice based on our experience in practice. In this edition, we take a bird’s eye view over the two main legal structures used by management companies taking flight abroad.

International expansion is a practical reality for many a hotel management company – whether it’s an operator looking to manage a hotel overseas for the first time, or a seasoned global brand opening up its first managed hotel in a virgin territory.

Generally speaking, when a company resident in Country A carries on business activities in Country B, then that company will be considered to have a “permanent establishment” in Country B. Usually this means that the company’s trading profits derived from its activities in Country B will be subject to corporate income tax under Country’s B’s tax laws. There may be other tax or legal implications, such as a requirement to incorporate a local branch or subsidiary company in Country B for the purpose of carrying out the business activities there.

The interesting question this raises is: is a hotel management company (“Manager”) resident in Country A that manages a hotel in Country B carrying on a business activity in Country B (thereby creating a taxable presence)?

The intuitive answer is normally, “yes”. Under an HMA, the Manager will be managing almost all aspects (including the day-to-day) of the hotel in Country B on the hotel owner’s (“Owner”) behalf, and so it would seem obvious the Manager is carrying out business activities in Country B (and to defy logic to say otherwise). We will call this view the “In Country Model”.

If we take a closer look at the various elements of a standard HMA structure, however, is it possible to come to a different view?

Under a standard HMA structure: the hotel land will be owned or leased by the Owner, the hotel business will be in the Owner’s name (with all incomings and outgoings in the Owner’s name and under the Owner’s VAT/tax registration) – and lastly, the Owner will (usually) be the legal employer of the hotel staff. In this light – it is somewhat difficult to pinpoint exactly “where” the Manager is within the hotel business.

Taking this thought further – it’s possible to view the Manager, based in Country A, as providing external management consultancy services from Country A to the Owner (and the hotel) in Country B. In other words, the Manager is, from Country A, providing advice, direction and control to the Owner (via the senior hotel staff) on how to manage and operate the Owner’s hotel business in Country B. The Manager may also even be licensing its brand and certain other IP for the Owner to use. But, most importantly, the Manager is not actually carrying out any business activities “in” Country B. We will call this view the “Consultancy Model”.

Different Managers have taken different views on whether their activities fall within the In Country Model or Consultancy Model. The view will of course come down to the specific tax and legal landscape of the particular country in question (and other relevant commercial factors); and it’s common for the same Manager to use different models in different countries due to specific local factors. We discuss some of these considerations here.

On the face of it, the Consultancy Model is more attractive, mainly because it usually (in theory at least) avoids taxation in Country B, as well as the burden of creating a local branch or company and dealing with related issues, such as transferring the Manager’s income from the local branch/company in Country B to a parent company back in Country A. It does, however, carry more inherent risk. The main one being scrutiny from Country B’s tax authorities, which could result in fines, sanctions and other civil or criminal liability for the Manager (and potentially its officers/directors) – in addition to the admin burden of dealing with an investigation and any reputational fallout. There could also be a risk of the Consultancy Model making an HMA unenforceable against an Owner on the grounds of being a legally invalid structure.

On the other hand, the In Country Model is usually less tax efficient, by subjecting the Manager’s income to Country B’s tax regime. That being said, there are ways of mitigating the tax impact through restructuring the Manager’s fee and contracting structure, and applicable tax exemptions or double taxation treaties may also help.

From a non-tax perspective, using the In Country Model will usually mean the HMA exists as a contract between two “local” entities, which in some jurisdictions can carry mandatory legal requirements such as the HMA being drafted in local language and subject to local governing law and courts (and which would not apply if the HMA was with a foreign Manager entity).

There may, however, be strong operational drivers for using an In Country Model, such as enabling the Manager to employ some or all hotel staff (which can be extremely problematic in some jurisdictions without a local corporate presence).

The decision as to whether to use an In Country or Consultancy Model is an important one, and specific advice needs to be taken on a case by case basis to enable a Manager to weigh up and take a view on the competing risks and benefits.

Depending on the model used, the Manager’s HMA documentation should then be reviewed and tailored (as needed) to reflect and support that model and address any specific local risks.