Governments and tax authorities around the world are responding to globalization, economic uncertainty and the connected economy by imposing tighter trading rules and pursuing tax revenue with ever more determination.
For a U.S. company looking to expand overseas, major tax issues need to be addressed prior to actual expansion. These issues relate to structuring, repatriation of profits, transfers of intangible property and transfer pricing.
Structuring the foreign operation
There are different legal forms for conducting business abroad. Most have advantages and disadvantages that should be dealt with in each particular situation.
The legal form adopted will depend on many circumstances involving U.S. and foreign country issues, such as the type of business the company is planning to conduct as well as the income expected. In broad terms, the options for setting up a foreign operation, along with the advantage and disadvantage of each, are summarized on the chart at right.
Repatriation of profits
This issue has to be thoroughly studied for each particular case. Often, advice for this is provided by a consultant who addresses the U.S. side of the situation but pays little attention to the disadvantages or opportunities that a certain strategy can bring in the host country.
It is always necessary to be aware of all the tax treaties that the United States has entered into in order to avoid double taxation. However, there might be opportunities to minimize or defer the taxes paid by the U.S. parent company.
Though there are a number of strategies with a high degree of complexity, as long as the subsidiary does not distribute the earnings (with certain exceptions), the income will not be taxable in the United States.
Intellectual property and intangible assets
To avoid paying U.S. taxes until profits are repatriated and to create enough protection for the company’s intangible assets, the following structure is widely used.
- When a U.S. parent company files a patent with the U.S. Patent and Trademark Office, it is advisable that the filing take place under the Patent Corporate Treaty, in which all the listed countries, including the United States, are designated.
- Then the U.S. parent company sets up an offshore holding company located in a low-tax jurisdiction.
- This offshore unit buys a stake in the parent’s existing patent before it starts to generate any value. This patent is developed jointly by the parent company and the offshore company under a cost-sharing arrangement.
- The offshore company licenses the patent to another foreign subsidiary, which collects royalties from all foreign subsidiaries that sell the parent company’s products to foreign customers.
- Finally, a portion of these royalties is paid to the U.S. parent and is subject to U.S. tax. The balance is left in the low-tax offshore company and is not subject to current U.S. taxation.
Transfer pricing issues
In general, whenever there is a transfer of goods or services between related foreign parties, the taxing jurisdictions involved want to ensure that the price set is an “arms-length” price. To substantiate the price as arms-length, companies are required to prepare transfer pricing studies that follow the local regulations.
In this regard, it is important to note that a U.S. transfer pricing study, while valid for U.S. tax purposes, is not binding in the foreign jurisdiction. Therefore, it is important to coordinate these studies.
Multinational businesses are increasingly affected by tax, legislative and regulatory developments throughout the world. Understanding the impact of these developments on business operations and transactions between countries is vital for a company’s survival.
LONNIE E. DAVIS, CPA, is director of tax advisory services, CBIZ Accounting, Tax & Advisory Services, Philadelphia/Plymouth Meeting. CBIZ, a publicly traded company and the 10th largest accounting firm nationally (Accounting Today), provides a wide range of assurance, tax and consulting services to small and mid-sized companies. Reach him at (610) 862-2200 or [email protected].