With global tax reform shifting toward greater tax transparency and governments in need of revenue, U.S. companies seeking to expand into new markets or establish new businesses internationally should carefully consider these international tax-related questions.
- Do you have a permanent establishment (PE)?
A company with a taxable presence (a PE) in another country faces foreign filing and tax paying obligations. Without a PE, tax treaties may limit the foreign country’s ability to tax the company.
- To defer or not to defer?
The profits of a foreign corporation are generally not taxed in the United States until they are repatriated. However, the foreign earnings of S corporations, partnerships, or other flow-through entities are taxed currently to their U.S. owners. Generally speaking, deferring U.S. tax is desirable if low foreign taxes leave more earnings available to reinvest in foreign operations. However, after the Tax Cuts and Jobs Act (TCJA) passed in 2017, achieving deferral has become much more complex.
- Does an IC-DISC make sense?
The United States provides incentives to qualified producers or distributors who are directly involved in exporting or selling products to distributors or wholesalers outside of the U.S. Taxpayers may exclude tax commissions paid to an Interest-Charge Domestic International Sales Corporation (IC-DISC) for supporting overseas sales. When ultimately paid to individual IC-DISC shareholders, IC-DISC commissions are ultimately taxable at a 20% rate instead of the much higher corporate and/or individual rates that apply to ordinary business income. IC-DISCs involve little cost, but a new legal entity must be established, a timely election must be made, and the DISC must meet specific other requirements. The TCJA made significant changes to the U.S. tax system; however, an IC-DISC can still provide tax benefits to U.S. companies that export goods.
- What about transfer pricing?
U.S. and foreign tax authorities often assert that related party transactions improperly understate income. Companies new to international taxes often do not understand the complexities involved with developing a defensible transfer pricing policy. Failure to maintain documentation that proves intercompany transactions are conducted at arm's length could result in substantial penalties.
- Have you reported all foreign bank accounts?
At any time throughout a calendar year, U.S. taxpayers with a financial interest in, or signature or other authority over, a foreign bank account with a balance of $10,000 or more must file a Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury department. Most taxpayers who venture abroad must open a foreign account to support their local business activities, and many are unaware of their filing obligations.
- What about your employees?
U.S. companies often send their best people to open a new office in a foreign location. Aside from whether such activities create tax nexus for the company (they usually do), the employees themselves may face tax and filing obligations in the host country. Moreover, they will also face tax and filing obligations in the United States if they are U.S. citizens because, unlike virtually every other country in the world, the United States asserts tax jurisdiction over its citizens, regardless of where they live or work. Therefore, U.S. companies should consider and quantify the impact of a foreign assignment on their employees and determine whether tax equalization is appropriate.
- Beware the toll charge on outbound transfers.
Companies that shift business assets offshore may unknowingly trigger a U.S. tax on the transfer. Generally speaking, the tax law allows companies to reorganize their business assets without triggering tax implications. However, transfers of business assets to a non-U.S. business entity could trigger a U.S. tax unless the taxpayer follows special regulatory rules, including filing certain notices with the IRS.
The decision to expand your business operations in another country is unique to your company. The tax questions provided above could impact the entity structure you choose, and all of them should be considered when developing your global growth strategy including considering tax law changes domestically and internationally. Effective global structuring can reduce a company's global effective tax rate, increase operational efficiencies, and improve exit alternatives.