Tax Planning for Foreign Companies Doing Business in the United States and Beyond
Multinational entities including corporations and partnerships are subject to an array of tax systems in the countries where they have a presence or do business. Many companies employ in-house counsel and accountants to provide guidance regarding the particularities of the tax systems in the nations where they operate. However other corporations leverage the knowledge and experience of private CPAs and international tax attorneys who are extremely familiar with the tax code in their home country and its interplay with the international tax system. Outsourcing this role can lead to maximization of the organization or corporation’s profit through a deft navigation of the national and international tax concerns including the minimization of double taxation by utilizing relevant provisions of applicable tax treaties.
David W. Klasing is a dually qualified Tax Attorney and CPA. His education and experience as a dual credentialed professional allows him to consider the tax implications from the perspective of your bottom line while also taking into account potential legal and tax issues that could arise as the result of a particular approach or tax strategy. Furthermore, the firm provides a knowledgeable and experienced team of Attorneys, Accountants, and Bookkeepers that provide insightful and accurate guidance and administration of your tax and business concerns. To schedule a confidential reduced-rate consultation at the tax Law Offices of David W. Klasing call 800-681-1295 today or contact us online.
Financial and Legal Considerations Should the Business Elect to Form a U.S. Entity
After a careful and meticulous consideration of business goals, an individual or decision-making body may elect to form a U.S. entity or to open U.S. branches. This decision is subject to an array of factors however several chief considerations often include:
- The tax treatment the organization or entity will receive
- Ease of formation of the entity
- Ease of administration of the entity
- Protection the entity provides regarding imposition of personal liability
- The ease and ability to raise capital for the entity
- Exit strategies
These are the basic considerations that should be taken into account when forming a U.S. entity. An array of options are available, however many provide inadequate protections for members, owners, and other key parties.
Choice of Entities When Forming a Corporation or LLC to Do Business in the U.S.
There are an array of entities available for individuals to form in the United States including sole proprietorships, partnerships, limited liability companies (LLC), C Corporations, and S Corporations. However, sole proprietorships provide insufficient insulation of the member’s personal assets and S Corporations are not allowed to have foreign ownership. Therefore, in most cases, liability issues and the otherwise available options dictate that an interested party should chiefly consider the LLC or corporate forms.
When considering whether an LLC, or C Corp is the right choice for your U.S.-based entity, the chief consideration often comes down to whether it would be more advantageous for the LLC to elect tax treatment as a disregarded entity or to proceed with a C Corporate organization.
Understanding the tax treatment afforded C Corporations in the United States begins with a discussion of the corporate tax rates. This rate begins at 15 percent but quickly escalates to a rate of 34 percent for profits realized above a $75,000 threshold. Generally state and local income taxes apply, but these taxes are treated as deductions in relation to the federal tax obligation. U.S. corporations that issue dividend payments to foreign corporate parent companies are subject to a 30 percent withholding tax although this default rate is occasionally reduced by certain tax treaties. For example, the U.S.-Mexico treaty reduces this rate to 5 percent if the beneficial owner is a company which owns at least 10 percent of the voting stock of the company paying the dividends.
A single member LLC receives federal treatment as a “disregarded entity.” Disregarded entities are treated as if they are a branch of the foreign parent entity. Profits arising from or that are effectively connected to the U.S. branch are subject to the same corporate tax treatment along with a 30% branch profits tax. However there are some notable differences in tax treatment between U.S. corporations and foreign branches. For instance:
- Under the branch structure interest must be apportioned
- It is often difficult to control the timing of the imposition of the branch profits tax.
- There may be question or controversy as to whether tax treaty benefits are applicable to the entities operating under the branch method.
While the analysis is fact-specific for each and every potential entity, in many cases where tax treaties are a relevant consideration electing to treat the entity as a domestic corporation can result in more favorable tax treatment.
Potential Concerns Regarding Tax Treatment of Effectively Connected Income
Income that is considered effectively connected to the conduct of a U.S. trade or business will be taxed in the same manner as a U.S. citizen or domestic U.S. C Corporation. Consider that §8649(c) of the U.S. Tax Code holds that all income, gain, or loss arising from sources within the United States is effectively connected income. Exceptions to this rule are:
- Fixed annual or periodic income and capital gains from U.S. Sources are effectively connected income only when both of the following are true:
- The income or loss is derived from assets used or held for use in the conduct of U.S. trade or business
- The U.S. trade of business activities were a material factor in the gain or loss. Foreign members of partnerships of which the partnership is engaged in U.S. trade or business is considered to be engaged in the same.
- Corporations or entities that do not maintain a U.S. office or fixed place of business in the U.S. or do not have income attributable to that office do not have effectively connected income.
Whether operations will give rise to effectively connected income is an important issue to consider and plan for. Working with an experienced tax lawyer who is familiar with governing statutes and case law can help avoid unexpected and less favorable tax treatment.
Filing Requirements for a Foreign-Owned Domestic U.S. Corporation
Depending on the corporation’s status as either a domestic U.S. corporation or a foreign corporation doing business in the United States, the organization is subject to certain filing obligations. For instance, a domestic corporation that maintains 25 percent foreign ownership is required to report certain information to the IRS via the filing of Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Under U.S. law a corporation is deemed to be 25 percent foreign owned when 25 percent or more of the total voting power or stock value is held by one or more non-U.S. persons at any time during the tax year. (Code Sec. 6038A(c)(1) Corporations that are obligated to file Form 5472 are also required to keep records the IRS has deemed necessary to determining proper tax treatment of transactions carried out with related parties.
Related parties include:
- Any 25 percent foreign shareholder of a domestic reporting corporation.
- Any person related to a reporting corporation or to a 25 percent shareholder of the reporting corporation
- Any other individual related to the reporting corporation.
Foreign corporations doing business in the United States are not considered reporting corporations per §6038A when the foreign corporation is not entitled to receive the benefits set forth in the business profits article of a bilateral income tax treaty and when the organization or entity does not have a permanent establishment located within the United States. Furthermore foreign corporations exempt from U.S. taxation must also fully and timely comply with filing to claim its exemption.
Other tax filing obligations to consider also include the fact that foreign related parties must authorize the corresponding domestic reporting corporation to serve as their agent should an IRS examination or audit arise. Additionally, this authorization also authorizes the acceptance of a summons arising from any transaction occurring with the reporting corporation. The failure to make these authorizations can give rise to a penalty for non-compliance.
Avoiding Transfer Pricing Penalties in Multinational Organizations
Transfer pricing regulations set forth how a related entity may set internal prices when transferring goods, services, loans, and intangible assets. These regulations apply in both domestic and international contexts. The general goal of transfer pricing standards is to provide an arm’s length standard designed to prevent tax evasion. The arm’s length standard is generally considered satisfied when the result of a controlled transaction is on par with that of an uncontrolled transaction. One method to avoid the potential imposition of penalties and potentially double tax by paying tax in multiple countries is to engage in negotiations to establish an advance pricing agreement with the IRS.
Guidance for Foreign companies and Corporations Doing Business in the United States
Foreign companies and corporations seeking to do business in the United States must carefully consider the tax implications their actions may have. Failure to engage in discussions of this type with an experienced tax lawyer can create the potential for increased costs realized through additional taxation. Furthermore, foreign entities that fail to comply with reporting or transfer pricing obligations can also face significant penalties. The tax professionals of the Tax law Offices of David W. Klasing can assist foreign businesses in their approach to the U.S. market. David and his team of experienced tax lawyers and accountants can discuss how your organization can minimize the potential effects of double taxation while remaining compliant with U.S. law. To schedule a confidential, reduced-rate tax consultation call 800-681-1295 or contact us online.