Foreign business expansion into the U.S.
by Kyle Lodder
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.
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 firstname.lastname@example.org. 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.