8 tax questions US companies should consider before expanding overseas
INSIGHT ARTICLE |
U.S. companies often find new markets, lower costs and less regulation overseas. But here are eight international tax questions they should answer before entering a foreign market.
- 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.
- Does a DISC make sense?
The United States provides incentives to boost exports of some domestic goods. Taxpayers may exclude tax commissions paid to a domestic international sales company (DISC) for supporting overseas sales. When ultimately paid to individual DISC shareholders, DISC commissions are ultimately taxable at a 20 percent rate instead of the much higher corporate or individual rates that apply to ordinary business income. DISCs involve little cost, but a new legal entity must be established, a timely election must be made and the DISC must meet certain other requirements.
- 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?
U.S. taxpayers with a financial interest in, or who have signature authority over, a non-U.S. bank account must report the existence of the account to the Financial Crimes Enforcement Network (FinCen) or face potential civil and criminal penalties. 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. 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 the filing of certain notices with the IRS. The taxpayer may also need to enter into a special agreement with the IRS to defer current taxation, but will have to recognize gain later if business assets are sold.
- What about tax reform?
Congress is considering major tax reform that could significantly alter the tax landscape, including reduced corporate and individual tax rates, and possibly a tax exemption for income earned abroad. Now more than ever, companies going offshore should carefully consider the impact of both existing law and relevant tax proposals.
Taking your business or selling your products overseas can present great opportunities for growth. Business executives that address key potential tax issues in advance can minimize potential tax risks and maximize bottom-line profits.