The inbound guide summary to US corporate tax
Foreign investment plays an important role in the US economy. According to the latest data from United Nations Conference on Trade and Development, the United States had more foreign direct investment from 2006 through 2009 than any other country in the world. Majority owned US affiliates of foreign parents produced $670 billion in goods and services, accounting for nearly 6% of total US private output in 2008. In addition, foreign investors in the US invested $188 billion in capital expenditures and $40.5 billion in research and development. Despite the economic downturn, which resulted in a 50% drop in foreign investment in the United States between 2007 and 2009, foreign investment activity in the United States remains strong and has increased by 49% from the economic crisis level it reached in 2009.1 Indeed President Obama affirmed the value of investments by foreign-domiciled companies to the US economy and made a commitment to treat all investors in a fair and equitable manner so that the United States remains the “destination of choice for investors around the world.” 2
As the world’s largest economy, the United States provides abundant opportunities in which to operate, an innovative and productive workforce, excellent infrastructure and lucrative consumer and business-to-business markets. It also delivers a tax code that covers more than 17,000 pages — not to mention common law precedent. Although not all provisions necessarily apply to inbound investors, you must navigate your way through sometimes vague (and often confusing) tax regimes at the national, state and local levels to maximize the possibilities and manage the risks. Missteps and missing information can create undue risk and affect the ultimate success of your cross-border operations. I am here to help.
We know that every business has a unique set of circumstances and attributes that trigger specific tax obligations. That said, there are certain overarching regulations, policies and approaches that can help make the process of doing business in the US smoother. This is designed to provide you with a ready guide to some of that information. However, we urge you to consult with a qualified and trusted advisor before you make any significant business or tax-related decisions to more fully understand what impact the US tax code and financial landscape may have on your corporate entity. Structuring your US business entity and activities;
There are number of ways in which your inbound company can structure business activities in the US, depending upon your business model. What is important is choosing a structure that is compatible with the way the group anticipates operating in the US. Just remember not to do anything purely for tax reasons. That said, there will be tax consequences to your choices, so be sure to consider those in advance as well.
US tax authorities assume that a business purpose exists for so-called “greenfield” opportunities — opportunities that are largely unexplored and undefined. Based on that premise, investors are allowed to arrange their operations as they see fit. Initial transactions in a Greenfield investment are presumed to be for some business purpose and not solely for the purpose of tax avoidance.
Forms of enterprise and their tax implications
How you structure your long-term operations in the US effectively defines how you will be taxed, so the choice can have a potentially significant impact on profitability. US Treasury regulations generally allow many business entities to choose classification as a corporation, partnership or entity disregarded from its parent. There are flow-through entities, unincorporated branches and Limited Liability Companies (LLCs). There are distributor and manufacturer representatives, joint ventures and partnerships. Where will the head office be located and what activities will go on in the US? Each choice has its own implications, complications and criteria. The various ownership structures also have financing, legal liability and growth flexibility issues. So given several viable structures that could work for your business, how do you decide which one to choose? Typical business models include a representative office, branch office or wholly owned subsidiary
Representative office.
A representative office is the easiest option for a company starting to do business in the US. You do not have to incorporate a separate legal entity and you will not trigger a corporate income tax, 5 as long as the activities are limited in nature. That would include such ancillary and support activities as advertising and promotional activities, market research and the purchase of goods on behalf of the headquarters office. A representative office is most appropriate in the very early stages of your corporation’s business presence in the US. Then, you may want or need to transition to a branch or subsidiary structure as your business in the US grow. You and your advisor should periodically review the suitability of your structure and its activities to make sure that you are not inadvertently triggering a taxable presence in the US by exceeding the permissible activities. Branch
A branch structure is similar in nature to a representative office in that it does not require incorporating a separate legal entity. The benefit of having a branch rather than a representative office is that the range of activities that can be performed by a US branch office can be substantially increased. That will, however, constitute a taxable presence in the US, which means that you must annually account for and file US corporate income tax on the branch’s profits. Generally, the branch is subject to a corporate tax rate of up to 35%6 in the US. In addition, any remittance of post-tax profits by the branch to the head office is subject to branch remittance tax of 30%. However, US tax treaties typically reduce the branch remittance tax.
A branch structure is suitable when you anticipate incurring losses in the near future or repatriating profits on a current basis. The US branch’s trading losses can be offset against the home office’s trading profits. In a reverse situation, where the branch is profitable, the parent company may also be subject to tax in the home country on the US profits. Keep in mind that an inbound corporation considering a branch structure may expose a disproportionate share of the parent company’s profits to a higher US tax rate since attributing the profits to branch activities requires arm’s length consideration. There is also a risk that intangibles such as intellectual property and brand identity may build up in the US over time. That could give rise to larger US tax liabilities in the longer term as the group becomes more successful in the US marketplace because these intangibles would necessitate attributing more of the profits to the branch.
Subsidiary
In a subsidiary structure the inbound company incorporates a wholly owned subsidiary in the US, making it a separate legal identity distinct from the parent company. This can be used to cap any risks that may be inherent in a branch option. The profits earned by the US subsidiary would be liable to tax in the US at up to 35%7. Further, the repatriation of profits (dividend distribution) by the US subsidiary to the parent is subject to a withholding tax of 30%. However, US tax treaties typically reduce the dividend withholding tax. The chart on the following page provides a high-level look at some of the considerations specific to each of the three typical models.
Tax treaties, the US has income tax treaties with more than 60 foreign countries, providing substantial benefits by reducing or eliminating the 30% withholding tax on US source FDAP income. In addition, US business profits can only be taxed to the extent that the foreign person’s involvement in the United States rises to the level of a permanent establishment. Generally, a PE does not include activity that is considered auxiliary and preparatory. The threshold for a PE is higher than the threshold of a US trade or business, and an entity that might otherwise be subject to US net tax on ECI can be exempted under an applicable treaty from paying federal income tax if its level of activity does not rise to the threshold of a PE. The exemption from paying tax does not exempt the foreign person from otherwise applicable filing obligations (e.g., an annual income tax return).
What may come as a surprise to treaty countries is that under the US Constitution, treaties and laws passed by Congress are the “supreme Law of the Land” and have equal authority. That means US statutory guidance requires only that “due regard” be given to treaties. In addition, US case law generally supports the idea that precedence be given to the most recently enacted authority. Thus, it is possible for Congress to enact laws overriding existing US treaty commitments. Even when the treaties are upheld, they do not govern taxation by the individual states.
To combat potential abuse of the treaty system, the US tax authorities have tried to limit the extension of treaty benefits to residents of a treaty country that satisfy three conditions:
1. Economic ownership — the resident must economically or beneficially own the income.
2. Tax ownership — the resident must be subject to tax on the income imposed by the treaty country as a resident of that country. An example of rules limiting treaty benefits due to tax ownership are the regulations regarding hybrid entities under IRC Section 894.
3. Economic nexus — the resident must have a sufficient economic nexus with the treaty country to establish that it is not merely using the country to obtain a tax advantage. Two restrictions on nexus are the Limitation on Benefits (LOB) articles, which define additional qualifications beyond mere residence that must be met, and triangular provisions, which deny or reduce benefits for certain income earned through a third-country PE. US tax authorities limit access to preferential treaty rates to entities that have economic ownership of the income eligible for treaty benefits.
Access to treaty benefits may be limited to the extent that the entity subject to tax does not have an economic nexus with the jurisdiction that is granting treaty benefits. Most US treaties have an LOB article that prevents non-residents from obtaining treaty benefits by establishing intermediary entities in treaty countries.
Controversy, misconceptions and potential trouble spots, Transfer pricing controversy
One consequence of this expanding global marketplace is the increasing potential for double taxation – the result of two or more taxing authorities attempting to tax the same profits because they do not agree with your transfer pricing. Experience tells us that the best plan is to assume controversy will happen and be prepared with a strategy for managing. Among the options are Advance Pricing Agreements (APAs), Competent Authority relief and arbitration.
Accidental expatriates, Employees living and working outside their home country are typically referred to as expatriates. That arrangement would generally involve your human resource department and include a predetermined contract that takes into account the tax and other business ramifications for both the individual and the company, at home and abroad. But what happens when the employee or contractor is sent to the US for only a short-term assignment or immediate business requirement without following formal procedures? Depending upon some clear — and less clear — factors and circumstances, such as length of stay or amount of compensation earned while in the US, you may have created an accidental expatriate.
The activities of these individuals can carry significant risk for you and your employees, primarily:
• Non-compliance with US immigration, tax and social security laws
• Double taxation of business profits by the home country and the US
• Assessment of penalties
• Failure to properly budget and allocate costs
• Employee exposure to taxation related to short-term international business travel
Keep in mind that although our handbook is specific to inbound companies doing business in the US, accidental expatriates can arise in other countries as well. The best approach is not to take any overseas business travel lightly, and to make sure that your local and US human resource professionals are involved in any contract and placement processes.
Treaties and state tax liability foreign investors in the United States should also keep in mind that availability of treaty benefits to offset the federal taxation of income may not necessarily apply to mitigating state income tax. As a general rule, states are not a party to tax treaties between the United States and foreign nations. In fact, some states, such as California, do not recognize the PE article of the US income tax treaties and do not contain any other rules that would exempt income generated by activities in their state from state income tax. For example, assume a Foreign Corporation (FC) sells goods on an arm’s length basis to its wholly owned US subsidiary, a California corporation, (US Sub) on consignment. US Sub then sells the goods on its own behalf to independent retailers and wholesalers throughout the United States. FC has no employees in the US and conducts no other business in the US. Pursuant to the treaty, FC’s US activities may not rise to the level of a permanent establishment, so FC may not be subject to US federal income tax. However, the apportioned net California source income generated by the activities would be subject to California income tax. That means FC would need to file in California to report its worldwide income and apportion that to California based on that state’s tax laws.
Winston Wambua
International Offshore Specialist
For more information please contact me on
Foreign investment plays an important role in the US economy. According to the latest data from United Nations Conference on Trade and Development, the United States had more foreign direct investment from 2006 through 2009 than any other country in the world. Majority owned US affiliates of foreign parents produced $670 billion in goods and services, accounting for nearly 6% of total US private output in 2008. In addition, foreign investors in the US invested $188 billion in capital expenditures and $40.5 billion in research and development. Despite the economic downturn, which resulted in a 50% drop in foreign investment in the United States between 2007 and 2009, foreign investment activity in the United States remains strong and has increased by 49% from the economic crisis level it reached in 2009.1 Indeed President Obama affirmed the value of investments by foreign-domiciled companies to the US economy and made a commitment to treat all investors in a fair and equitable manner so that the United States remains the “destination of choice for investors around the world.” 2
As the world’s largest economy, the United States provides abundant opportunities in which to operate, an innovative and productive workforce, excellent infrastructure and lucrative consumer and business-to-business markets. It also delivers a tax code that covers more than 17,000 pages — not to mention common law precedent. Although not all provisions necessarily apply to inbound investors, you must navigate your way through sometimes vague (and often confusing) tax regimes at the national, state and local levels to maximize the possibilities and manage the risks. Missteps and missing information can create undue risk and affect the ultimate success of your cross-border operations. I am here to help.
We know that every business has a unique set of circumstances and attributes that trigger specific tax obligations. That said, there are certain overarching regulations, policies and approaches that can help make the process of doing business in the US smoother. This is designed to provide you with a ready guide to some of that information. However, we urge you to consult with a qualified and trusted advisor before you make any significant business or tax-related decisions to more fully understand what impact the US tax code and financial landscape may have on your corporate entity. Structuring your US business entity and activities;
There are number of ways in which your inbound company can structure business activities in the US, depending upon your business model. What is important is choosing a structure that is compatible with the way the group anticipates operating in the US. Just remember not to do anything purely for tax reasons. That said, there will be tax consequences to your choices, so be sure to consider those in advance as well.
US tax authorities assume that a business purpose exists for so-called “greenfield” opportunities — opportunities that are largely unexplored and undefined. Based on that premise, investors are allowed to arrange their operations as they see fit. Initial transactions in a Greenfield investment are presumed to be for some business purpose and not solely for the purpose of tax avoidance.
Forms of enterprise and their tax implications
How you structure your long-term operations in the US effectively defines how you will be taxed, so the choice can have a potentially significant impact on profitability. US Treasury regulations generally allow many business entities to choose classification as a corporation, partnership or entity disregarded from its parent. There are flow-through entities, unincorporated branches and Limited Liability Companies (LLCs). There are distributor and manufacturer representatives, joint ventures and partnerships. Where will the head office be located and what activities will go on in the US? Each choice has its own implications, complications and criteria. The various ownership structures also have financing, legal liability and growth flexibility issues. So given several viable structures that could work for your business, how do you decide which one to choose? Typical business models include a representative office, branch office or wholly owned subsidiary
Representative office.
A representative office is the easiest option for a company starting to do business in the US. You do not have to incorporate a separate legal entity and you will not trigger a corporate income tax, 5 as long as the activities are limited in nature. That would include such ancillary and support activities as advertising and promotional activities, market research and the purchase of goods on behalf of the headquarters office. A representative office is most appropriate in the very early stages of your corporation’s business presence in the US. Then, you may want or need to transition to a branch or subsidiary structure as your business in the US grow. You and your advisor should periodically review the suitability of your structure and its activities to make sure that you are not inadvertently triggering a taxable presence in the US by exceeding the permissible activities. Branch
A branch structure is similar in nature to a representative office in that it does not require incorporating a separate legal entity. The benefit of having a branch rather than a representative office is that the range of activities that can be performed by a US branch office can be substantially increased. That will, however, constitute a taxable presence in the US, which means that you must annually account for and file US corporate income tax on the branch’s profits. Generally, the branch is subject to a corporate tax rate of up to 35%6 in the US. In addition, any remittance of post-tax profits by the branch to the head office is subject to branch remittance tax of 30%. However, US tax treaties typically reduce the branch remittance tax.
A branch structure is suitable when you anticipate incurring losses in the near future or repatriating profits on a current basis. The US branch’s trading losses can be offset against the home office’s trading profits. In a reverse situation, where the branch is profitable, the parent company may also be subject to tax in the home country on the US profits. Keep in mind that an inbound corporation considering a branch structure may expose a disproportionate share of the parent company’s profits to a higher US tax rate since attributing the profits to branch activities requires arm’s length consideration. There is also a risk that intangibles such as intellectual property and brand identity may build up in the US over time. That could give rise to larger US tax liabilities in the longer term as the group becomes more successful in the US marketplace because these intangibles would necessitate attributing more of the profits to the branch.
Subsidiary
In a subsidiary structure the inbound company incorporates a wholly owned subsidiary in the US, making it a separate legal identity distinct from the parent company. This can be used to cap any risks that may be inherent in a branch option. The profits earned by the US subsidiary would be liable to tax in the US at up to 35%7. Further, the repatriation of profits (dividend distribution) by the US subsidiary to the parent is subject to a withholding tax of 30%. However, US tax treaties typically reduce the dividend withholding tax. The chart on the following page provides a high-level look at some of the considerations specific to each of the three typical models.
Tax treaties, the US has income tax treaties with more than 60 foreign countries, providing substantial benefits by reducing or eliminating the 30% withholding tax on US source FDAP income. In addition, US business profits can only be taxed to the extent that the foreign person’s involvement in the United States rises to the level of a permanent establishment. Generally, a PE does not include activity that is considered auxiliary and preparatory. The threshold for a PE is higher than the threshold of a US trade or business, and an entity that might otherwise be subject to US net tax on ECI can be exempted under an applicable treaty from paying federal income tax if its level of activity does not rise to the threshold of a PE. The exemption from paying tax does not exempt the foreign person from otherwise applicable filing obligations (e.g., an annual income tax return).
What may come as a surprise to treaty countries is that under the US Constitution, treaties and laws passed by Congress are the “supreme Law of the Land” and have equal authority. That means US statutory guidance requires only that “due regard” be given to treaties. In addition, US case law generally supports the idea that precedence be given to the most recently enacted authority. Thus, it is possible for Congress to enact laws overriding existing US treaty commitments. Even when the treaties are upheld, they do not govern taxation by the individual states.
To combat potential abuse of the treaty system, the US tax authorities have tried to limit the extension of treaty benefits to residents of a treaty country that satisfy three conditions:
1. Economic ownership — the resident must economically or beneficially own the income.
2. Tax ownership — the resident must be subject to tax on the income imposed by the treaty country as a resident of that country. An example of rules limiting treaty benefits due to tax ownership are the regulations regarding hybrid entities under IRC Section 894.
3. Economic nexus — the resident must have a sufficient economic nexus with the treaty country to establish that it is not merely using the country to obtain a tax advantage. Two restrictions on nexus are the Limitation on Benefits (LOB) articles, which define additional qualifications beyond mere residence that must be met, and triangular provisions, which deny or reduce benefits for certain income earned through a third-country PE. US tax authorities limit access to preferential treaty rates to entities that have economic ownership of the income eligible for treaty benefits.
Access to treaty benefits may be limited to the extent that the entity subject to tax does not have an economic nexus with the jurisdiction that is granting treaty benefits. Most US treaties have an LOB article that prevents non-residents from obtaining treaty benefits by establishing intermediary entities in treaty countries.
Controversy, misconceptions and potential trouble spots, Transfer pricing controversy
One consequence of this expanding global marketplace is the increasing potential for double taxation – the result of two or more taxing authorities attempting to tax the same profits because they do not agree with your transfer pricing. Experience tells us that the best plan is to assume controversy will happen and be prepared with a strategy for managing. Among the options are Advance Pricing Agreements (APAs), Competent Authority relief and arbitration.
Accidental expatriates, Employees living and working outside their home country are typically referred to as expatriates. That arrangement would generally involve your human resource department and include a predetermined contract that takes into account the tax and other business ramifications for both the individual and the company, at home and abroad. But what happens when the employee or contractor is sent to the US for only a short-term assignment or immediate business requirement without following formal procedures? Depending upon some clear — and less clear — factors and circumstances, such as length of stay or amount of compensation earned while in the US, you may have created an accidental expatriate.
The activities of these individuals can carry significant risk for you and your employees, primarily:
• Non-compliance with US immigration, tax and social security laws
• Double taxation of business profits by the home country and the US
• Assessment of penalties
• Failure to properly budget and allocate costs
• Employee exposure to taxation related to short-term international business travel
Keep in mind that although our handbook is specific to inbound companies doing business in the US, accidental expatriates can arise in other countries as well. The best approach is not to take any overseas business travel lightly, and to make sure that your local and US human resource professionals are involved in any contract and placement processes.
Treaties and state tax liability foreign investors in the United States should also keep in mind that availability of treaty benefits to offset the federal taxation of income may not necessarily apply to mitigating state income tax. As a general rule, states are not a party to tax treaties between the United States and foreign nations. In fact, some states, such as California, do not recognize the PE article of the US income tax treaties and do not contain any other rules that would exempt income generated by activities in their state from state income tax. For example, assume a Foreign Corporation (FC) sells goods on an arm’s length basis to its wholly owned US subsidiary, a California corporation, (US Sub) on consignment. US Sub then sells the goods on its own behalf to independent retailers and wholesalers throughout the United States. FC has no employees in the US and conducts no other business in the US. Pursuant to the treaty, FC’s US activities may not rise to the level of a permanent establishment, so FC may not be subject to US federal income tax. However, the apportioned net California source income generated by the activities would be subject to California income tax. That means FC would need to file in California to report its worldwide income and apportion that to California based on that state’s tax laws.
Winston Wambua
International Offshore Specialist
For more information please contact me on
No comments:
Post a Comment