GLOBAL-Preneuring

Tax ramifications can make or break a
worldwide enterprise.

Globalization has become an important growth strategy for many small businesses. Once you’ve decided to set up a foreign office or manufacturing facility overseas, it’s wise to carefully consider the tax ramifications of a global enterprise.

Before expanding abroad, business owners should consult with a tax advisor in both their home country and the foreign country. These professionals can help decide on the most advantageous business structure for your company, as well as offer advice on what to expect with the tax regime in the foreign country.

Your company’s structure will help determine what taxes you pay internationally. The international tax difference among types of entities can be dramatic.

Most countries have classifications similar to those in the U.S., whether it be a stock corporation, partnership or limited liability company. Each country also has its own political, social or economic pressures that dictate what type of entity is most appropriate.

It’s also important for global entrepreneurs to consider the types of taxes levied in the foreign country. Just as in the U.S, there are different layers of taxes in most foreign countries. In addition to income taxes, corporations are subject to a second level of tax on dividends. Then there are social taxes (equivalent to social security in the U.S.), property taxes, transfer taxes, local taxes and the Value Added Tax (VAT). The VAT is a tax somewhat similar to our sales tax, but it is imposed at varying levels from production to distribution.

Typically, there are withholding taxes levied on transfers of money from the foreign country to a person in another country, in the form of interest or dividend payments. The withholding rate is high.

Bilateral Tax Treaties
To minimize the impact of foreign taxes, entrepreneurs should also determine if there is a bilateral tax treaty between their home country and the country in which they intend to do business. These treaties have been negotiated to help alleviate the likelihood of having both countries tax the same transaction. They also act as tie-breakers, to determine which country taxes a particular transaction.

Companies can also save dollars by properly claiming benefits.

For example, Company A, located in Country X, forms a wholly owned subsidiary corporation, Company B, located in Country Y. Company B intends to pay a dividend of $100,000 back to Company A, and that dividend is determined to be sourced to Country Y. Further, Country Y imposes a 30 percent withholding tax on dividends paid to non-resident shareholders. However, Countries X and Y have a tax treaty that says dividend withholding tax is 5 percent, if made between companies located in the respective countries. Without claiming the treaty benefit, the amount of cash transferred to Company A would be $20,000 or 20 percent less than if they had properly claimed benefit from the treaty.

Another issue facing entrepreneurs operating abroad is that income earned by U.S. companies and residents in a foreign country is still taxable in the U.S.

There are provisions that provide for a credit of some or all of the taxes paid on that income, but the income is still taxable in the U.S. Because of this, entrepreneurs should consider how their choices in doing business abroad will affect their tax position—both in the country and the U.S.

Choosing the right structure for your business is no easy task, with constant changes affecting global U.S. companies. The U.S. tax code provides for a wide range of options in determining how foreign income is taxed in the U.S, as well as restrictions that narrow those options under certain circumstances.

Companies can exercise their option to treat a foreign operation in one manner or another through a set of regulations known as the “check-the-box rules.”

These regulations have opened the door for international business structures known as hybrid entities. These hybrids are foreign subsidiaries that are taxed in the foreign country in one manner—such as a corporation—but treated in the U.S. as something different—such as a partnership. However, this structure is strictly for U.S. tax purposes.

If your foreign subsidiary is a branch or partnership, the income of the subsidiary will, by default, be included on the U.S. parent company’s income tax return. If the subsidiary is expected to generate losses, these should be available to offset U.S. income.

If the subsidiary is a corporation, the “separate legal entity” concept comes into play. The income generated in the foreign country will generally not be subject to U.S. tax, as long as the earnings stay abroad. However, any money sent back to the U.S. parent will be subject to a tax on dividends, as well as a substantial set of U.S. tax regulations.

If you choose for your subsidiary to be a foreign branch under the foreign country’s legal system and later want to incorporate that branch, there could be significant tax ramifications, both in the U.S. and in the foreign country.

In some countries, it might be more advantageous to form your subsidiary as a corporation. However, for U.S. purposes, you might be better served to treat that subsidiary differently.

You must generally select your corporate structure within 75 days of either the formation of the company or the date business commences. Not making the right choice early could end up being a costly mistake. •