By
Kyle Lodder, CPA
The
United States continues to be a large and stable economy and an
attractive destination for non-U.S. companies to expand and grow
their business. Even though it’s an attractive market for
businesses to penetrate, foreign business owners often experience
difficulty navigating the complex tax, legal and regulatory rules.
Therefore,
it’s critical that one engages a qualified team of advisors as one
enters the U.S. market. Proper planning will help avoid unexpected
consequences and allow the business owner to preserve his or her
time, money and mental space.N
A
foreign corporation engaged in a trade or business in the United
States is taxable on U.S. sourced business income. The activities
need to be “considerable, continuous, and regular” to rise to the
level of engaged in a U.S. business. The definition is quite broad
that many companies with sales in the U.S. fit into this category.
The
federal corporate income tax rate is comparatively high amongst
westernized countries. Taxpayers reach the highest marginal tax rate
of 35% at only $100,000 of corporate net income. As such, tax
planning and entity structuring is a critical component of the
planning for businesses expanding into the U.S.
A
partnership is an option to reduce U.S. federal income tax. In this
type of entity, the income is taxed at the individual partner level
and not with the partnership itself. Individual partners pay tax at
the individual income tax rates, which are significantly less in
comparison to corporate income tax rates.
The
partnership is required to withhold tax on behalf of the foreign
partners. The withholding tax is quite high as its equal to the
partners’ highest marginal tax rate multiplied by the foreign
partners’ share of business income. The foreign partners are able
to have much of this tax refunded when he or she files a U.S. income
tax return. However, the drawback to this approach is the significant
withholding taxes required which can cause a cash flow crunch in the
business.
The
U.S. federal estate tax should also be considered in the entity
structuring planning. Business ownership through a foreign
corporation is a technique to avoid attribution of the estate tax
upon death to the non-U.S. business owner.
Sometimes
a U.S. subsidiary corporation of the foreign corporation makes sense.
This approach can provide enhanced flexibility to mitigate U.S.
taxable income and to facilitate the repatriation of funds back to
the home country. Various techniques are implemented with this
structure, such as the use of intercompany loans with an interest
charge, management fees or dividends. With this approach, careful
professional guidance should be sought to avoid anti-abuse provisions
within U.S. tax law.
Perhaps
the most attractive option to mitigate the comparatively high U.S.
federal corporate income tax is to take advantage of the income tax
treaties between the U.S. and its trade partners. A list of the
income tax treaties can be found here:
https://www.irs.gov/businesses/international-businesses/united-states-income-tax-treaties-a-to-z.
Most of these treaties include a taxpayer friendly provision which
says that business profits of a foreign corporation are only taxable
in the United States if they are attributable to a Permanent
Establishment
in the United States.
Permanent
establishment typically includes a place of management, branch,
office, factory, workshop or an agent who habitually exercises an
authority to conclude contracts. A warehouse does not constitute a
permanent establishment.
As
such, the treaty may result in a foreign corporation only being
subject to income tax in the foreign country and not subject to U.S.
federal
income tax. A federal income tax return would still be required to
claim the benefits of the treaty. If the treaty-based return is not
filed, the Feds can potentially impose federal income tax on the
gross income earned in the U.S. without the benefit of any business
deductions.
Yet,
state tax compliance may be the most important tax issue to foreign
businesses expanding into the U.S. States generally don’t follow
federal tax laws or treaties. There are 13,000+ state and local
jurisdictions in the U.S. that impose taxes on businesses. Each
jurisdiction has their own set of rules and nexus standards. Nexus is
defined as the minimum presence in a jurisdiction subjecting the
company to tax in that given state or local jurisdiction. Oftentimes,
companies with no physical presence in the U.S. can avoid U.S.
federal income taxation through a tax treaty, but are still subject
to state tax since the nexus standards are met.
There
is not a one-size-fits-all solution for each non-U.S. business
expanding into the United States. Tax is a critical consideration and
proper planning can save thousands, even millions, of dollars and
avoid many head-aches and pitfalls. It’s prudent for business
owners to surround themselves with a qualified U.S. international tax
professional to help navigate the complex rules.
This
communication contains general information. Each individual investor
should discuss their specific situation with a professional advisor
before deciding on any investment structure.
If
you require additional information on any aspect of these complex
rules, please contact Kyle Lodder at 360.599.4340 or
kyle@loddercpa.com.
Kyle Lodder is a Certified Public Accountant and is the owner of
Lodder CPA PLLC, a U.S. international tax firm. Kyle has the
experience and knowledge to help Canadian investors weigh the
benefits and risks associated with the different investment options.
The
material appearing in this communication is for informational
purposes only and should not be construed as legal, accounting, or
tax advice or opinion provided by Lodder CPA PLLC. This information
is not intended to create, and receipt does not constitute, a legal
relationship, including, but not limited to, an accountant-client
relationship. Although these materials have been prepared by a
professional, the user should not substitute these materials for
professional services, and should seek advice from an independent
advisor before acting on any information presented. Lodder CPA PLLC
assumes no obligation to provide notification of changes in tax laws
or other factors that could affect the information provided.
