A Brief Discussion of Issues Relevant to U.S. Companies
A U.S. based business may seek to expand internationally for a number of reasons, including gaining access to overseas markets, for manufacturing, to merge with a foreign based business or to form strategic partnerships and alliances.
The planning for International expansion of any kind requires advance planning. To be considered are, at the least, tax Treaties, tax credit rules, foreign labor laws, country and local taxes, VAT issues, transfer pricing regulations, customs regulations, customs quotas and expenses, and of course, U.S. and foreign taxes and tax reporting and accounting requirements.
The U.S. has income tax treaties with most major trading partners, but not with all Countries. The IRS has developed tax information sharing agreements with many Countries, including "tax-haven" Countries which may not have a U.S. tax treaty.
Income tax treaties, and treaties governing employee benefits, are not identical and each relevant treaty must be closely examined. Income tax treaties cover corporate, commercial and personal tax obligations and generally serve to avoid double taxation through the tax credit system; however, the application of tax credits is limited and can be complicated. A U.S. corporation or person claiming a credit for foreign tax on income must have at least a 10% interest in the foreign entity earning the income, and the foreign tax paid must be a legal obligation and the U.S. parent or owner must exhaust reasonable remedies to avoid the tax or secure a refund. Furthermore, the credits are normally limited to income tax and not to other types of taxes such as the Value Added Tax (VAT) or local assessments not based on income.
A tax credit would not be allowed for dividends received by a U.S. LLC or S Corporation from its foreign corporate subsidiary because the shareholders are deemed to directly own the foreign corporation. The dividends might be taxed on the way out, unless reduced or exempt by treaty, and taxed again to the U.S. recipients. Some, but not all, types of foreign corporations are eligible for a U.S. "check the box election" to be treated as a tax-transparent entity for U.S. tax purposes which would allow the credit to the U.S. LLC or S Corporation owner. The choice of entity is critical and advance planning a must. Regulations are periodically issued restricting the use of foreign tax credits, and Congress may impose even more restrictions in any tax reform bill.
Tax Treaties commonly reduce or eliminate the tax at the source of dividends and interest payments, and royalty payments, and careful planning may take advantage of these reduced or zero rates of tax.
Tax treaties also determine when and if a U.S. company has a "permanent establishment", (PE) subject to country and local taxes and payment of employment benefits. This issue is often litigated, and each country has its own and evolving interpretation of a "permanent establishment". This can indeed be a tax trap, and the presence of a PE can take far less than having a physical office. For example, the designation of a foreign independent agent with substantial authority, such as to conclude agreements or appoint or hire sales representatives, or a significant level of service or sales, could trigger the deemed existence of a PE; the applicable law of each country must be examined, regardless of applicable Treaty language.
Transfer pricing, or the allocation of costs and prices between related companies, is a favorite target of the IRS and of foreign tax authorities, which all want to ensure that profits are not being unreasonably sent out of the country as a business expense tax deduction. The IRS is aggressive, actively auditing transfer pricing arrangements. It requires "contemporaneous" documentation to support transfer pricing, and professional review is highly recommended.
Foreign activity often involves foreign currency considerations, and currency "gains" can produce taxable income.
The U.S. imposes numerous reporting requirements on U.S. companies, on both "in-bound" and "out-bound" transactions. The list of reporting forms is outside the scope of this letter, but it is safe to assume that almost every form of foreign related transaction is covered by an IRS or Treasury form. Indeed, the extensive and increasing reporting requirements and the current aggressive IRS posture can be daunting and even anti-competitive to U.S. business. Failure to file required forms carries serious penalties.
While many foreign countries utilize "International Reporting Standards", the U.S. has not adopted this same standard, which can introduce a level of financial statement and reporting complication.
Active foreign manufacturing and/or service companies may be eligible for U.S. tax deferral under the "Subpart F" rules. If available, deferral of U.S. tax until repatriated can be very beneficial. Briefly stated, a U.S. company manufacturing overseas can defer U.S. tax on foreign profits (subject to transfer pricing rules) if the manufacturing occurs in the Country where the subsidiary is incorporated, or under now-sanctioned "contract manufacturing" rules, the foreign subsidiary contracts with a factory outside of its corporate domicile, but subject to strict rules.
A U.S. exporter or the provision of services (for example architectural services) can take advantage of the IC-Disc arrangement which can provide up to a 20% tax benefit.
If the U.S. Company plans on sending its own executives or employees to work in an overseas subsidiary, there are a myriad of issues to resolve, and this subject has been address in a previous Newsletter.
The various issues to be considered when expanding internationally can be resolved and with careful advance planning, doing business overseas can be well organized and profitable.