EXPANDING YOUR BUSINSS OVERSEAS
Your company is looking to either manufacture overseas or to sell product overseas, or both. And perhaps you have heard that holding Intellectual Property overseas might be a good idea.
Your business reasons for expanding overseas are sound, but you need to address some critical issues before proceeding. This letter highlights just some of those issues.
1. The local business laws of the Country or Countries involved must be reviewed to determine if your purposes will be diminished, made too expensive, or thwarted entirely. For example, some Countries require a local "partner" or shareholder, not an uncommon requirement in Asian and some South American Countries. Local customs and buying habits must be considered. And, of course, local custom might require paying "expediters" which, if such persons are at all related to government, could be an illegal payment under U.S. law (The Foreign Corrupt Practices Act), and, in any case make the whole project possibly too risky, expensive and uncertain.
2. You should get expert advice on local employment laws and customs, and the availability and costs of qualified labor. Many Countries, including Mexico, impose quite substantial employee benefit costs. In France, for example, hiring is easy but terminating an employee will make you older and wiser, at least certainly older. The EU purports to make life easier for Companies involved in EU transactions, but the devil is in the details.
3. If you intend to send local personnel overseas, considerations include expense, visa, and family issues; the personnel may not want to go overseas, or if they do go they might find that living there does not work for them and/or their families. The employee or executive on foreign assignment must consider compensation, health benefits, retirement plans, income taxes, business expense reimbursements, housing, dependents' education, foreign employment tax withholding, and estate planning.
4. The form or type of business entity is a threshold question, often determined by both U.S. tax issues and the relevant foreign tax rules. Applicable Tax Treaties require close analysis, and may offer tax planning opportunities; Tax Treaties are not all the same. You may think that any foreign tax paid will be applied as a credit against U.S. tax, but there are significant limitations on the application of U.S. tax credits. E- Commerce is indeed an evolving area of tax law, and several European Countries are attempting to devise systems to tax E-Commerce; advance planning in this area would be wise.
5. While it is true that the "tax tail should not wag the business dog", in fact failure to understand the relevant tax issues will likely kill the business dog anyway.
6. You may intend to transfer capital or other assets to a foreign subsidiary or related company. Capital might be provided as debt or equity, but relevant foreign rules on debt/equity ratios may be important.
7. The transfer of assets to a related foreign entity is not generally tax free, although transfer of (non-IP) assets to be used in the active conduct of the business receives favorable treatment. In general, the transfer of IP as a contribution to capital or as a sale to a related company requires that the transferor Company recognize anticipated royalty income for the "exploitation" of the IP, regardless of actual payments; this is a complex area requiring careful planning.
8. The concept of "permanent establishment" (PE) is a pervasive element of income tax Treaties and the tax laws of many Countries, including the U.S. If your business plan results in a foreign "permanent establishment", then local tax and other government charges and expenses may be assessed. Tax credits against U.S. tax will not apply to any but income tax payments, and subject to other limitations. This concept of 'Permanent Establishment" is indeed a subject of much litigation, The EU and other international groups (like the OECD) struggle with these rules.
9. Manufacturing overseas, while always complicated, might offer the opportunity to defer U.S. tax on profits to your foreign subsidiary. A foreign entity controlled by a U.S. person or company is considered a "controlled foreign corporation", and with specific exceptions, earned income of the foreign entity must be taken into current U.S. income. However, under the so-called "subpart F" rules, manufacturing profits (from sale to your U.S. Company or third parties) could be tax deferred until repatriated, if correctly organized. Transactions between related companies are governed by "transfer pricing "rules, which essentially means that the foreign profit must be reasonable as the U.S. does not want all the profits shifted overseas. Many Countries have similar rules and these are enforced. Ireland until recently had no such rules, but it too has now imposed intercompany pricing rules. The "contract manufacturing" exception allows, for example, a Hong Kong subsidiary to contract with an independent Chinese manufacturer, and reasonable profits to the Hong Kong subsidiary could be tax deferred (and Hong Kong might impose a modest tax. These rules are complex but offer a valuable planning opportunity.
IN SUMMATION, with the right advice and assistance, you should come up with a business plan that accomplishes your business plan in a tax efficient manner!