7 TAX QUESTIONS U.S. COMPANIES SHOULD CONSIDER BEFORE EXPANDING OVERSEAS
By Jim Carter
Establishing and maintaining an effective tax strategy for an internationally active business — or a business preparing to expand across borders — has never been easy. It requires the foresight to adapt tax strategies that fit the organization’s future plans, as well as its current operational needs.
The right international tax structure must balance the flexibility needed to adjust to the constant changes inherent in operating internationally, with the predictability and sustainability necessary to run a business.
Ideally, a cohesive international tax strategy accomplishes the following goals:
- Appropriately times tax and cash needs
- Takes full advantage of tax deferral opportunities
- Seizes foreign tax credit opportunities
- Avoids double taxation
- Appropriately controls overall tax exposure
Once that strategy is established, it requires careful attention to ensure continued alignment with both the constantly shifting international tax landscape and the organization’s corporate strategy.
The Shifting International Landscape
Across the globe, international tax planning strategies and processes are subject to heightened scrutiny as a number of jurisdictions are increasing their tax bases and limiting certain deductions.
The foundation for this rapidly changing landscape is the Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting (BEPS) project, which identified 15 Action Items aligned along three fundamental pillars:
- Establishing coherence in the domestic rules that affect cross-border activities
- Reinforcing substance requirements in the existing international standard
- Improving transparency
While countries are moving at varying speeds to implement BEPS, this initiative is driving the most significant changes in international taxation in decades and will affect virtually all internationally active middle-market companies. It will drive heightened reporting requirements and will almost certainly mean increased compliance costs and higher effective global tax rates for most international enterprises.
The Shifting Organizational Strategy
But external changes are not the only concern when it comes to maintaining tax strategies. Significant organizational changes such as entering new markets or cross-border mergers or acquisitions can affect the company’s international tax position, and should trigger a re-evaluation of strategy.
Of course, these changes can be beneficial for many organizations, as U.S. companies often find new markets, lower costs and less regulation overseas. So, while the idea of establishing — and then maintaining — an international strategy may be daunting, it’s well worth the effort.
Fortunately, there’s no need to start from scratch. Here are seven international tax questions to answer before entering a foreign market.
- Does the Company 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?
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 pricingpolicy. Failure to maintain documentation that proves intercompany transactions are conducted at arm’s length could result in substantial penalties.
- Have All Foreign Bank Accounts Been Reported?
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?
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 assignmenton 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.
Taking a business or selling its 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.
Jim Carter, CPA, is a Lead Tax Partner for RSM US LLP in San Antonio. He has more than 30 years of experience in public accounting and leads the firm’s International Business Services team. RSM US is a leading provider of audit, tax and consulting services focused on the middle market.