When a U.S. firm enters into an international joint venture while conducting business within American shores, the tax implications that arise from
the partnership grow substantially complex. Thus, businesses need to be aware of
when their foreign partnerships will create
a taxable situation. Could a manufacturing
agreement, a sales and distribution contract or a financing agreement with a foreign-based company create a partnership
for tax purposes?
Patrick W. Martin, head of the tax team at
San Diego-based Procopio, Cory, Hargreaves
& Savitch LLP, notes that the answer may not
be clear to the U.S. business owner. But one
thing is certain: such firms likely will engage
in a higher level of reporting, both of an informational nature and in an effort to meet IRS
rules concerning reportable events.
Smart Business spoke with Martin about
business arrangements between U.S. companies and their foreign counterparts and some
of the scenarios under which an American
entity would face a taxable situation.
When might a partnership exist for U.S. tax
purposes?
The words ‘joint venture’ and ‘partnership’ are often used interchangeably.
Generally, a joint venture is a partnership
that has one specific project or goal. An
international joint venture or ‘partnership’
for U.S. tax purposes may exist when a
U.S. firm has some sort of contractual
arrangement with another non-U.S. firm.
For example, a distribution arrangement
in the U.S. that’s conducted with a foreign
country could be considered a partnership for U.S. tax purposes. Or a joint venture with a company that assembles products for distribution to the U.S. could also
be considered a partnership for U.S. tax
purposes — especially when the entities
have some sort of sharing of profits and
losses.
A case in point is the maquiladora, a
Mexican manufacturing entity created
under Mexican law, which allows a factory
to receive imported materials and equipment free of duties and tariffs. The
maquiladora then either assembles or manufactures the product for resale to the foreign partner. At one time, the American
company that sold material to the Mexican
entity paid U.S. taxes and taxes to the
Mexican government.
Depending upon how the joint venture is
structured, there may be no foreign tax
credit to the U.S. entity, creating a double
taxation problem against the American
firm. Ideally, income taxes paid to the
Mexican or other foreign government
should be structured to offset — and can
be credited against — U.S. taxes.
A U.S. tax partnership could also exist
when the U.S. partner and the foreign partner wholly operate in the U.S. or when they
operate exclusively in another country.
The consequences then include the need to
meet information reporting requirements
in the U.S. of both the domestic and possibly the foreign partner.
When is a joint venture not a partnership for
U.S. tax purposes?
Businesspeople often talk about having
partnerships with another firm, usually an
industry leader or other brand-name foreign company, when actually all they have
is a relationship to provide a good or service at a set price. This is different from a partnership for tax purposes because the
situation does not give rise to specific tax-filing requirements.
If the business relationship is a partnership
for U.S. tax purposes, how will it be treated
under the laws of another country?
One country may not treat an enterprise as
a partnership; rather it may view the business as a separately taxed entity. Such businesses, for tax purposes, are referred to as a
hybrid entity. One country sees it as a partnership and the other as a corporation. In a
hybrid circumstance, you might not get
credit for foreign taxes paid, thereby subjecting the enterprise to double taxation.
Such inconsistencies in the tax system
make it necessary to carefully plan any joint
venture that crosses any national border.
You first have to understand the tax consequences your business activity will create,
and then plan accordingly so that you get
the cross-border tax results you want.
When might U.S. income tax treaties with
other countries apply to an international joint
venture?
Income tax treaties typically reduce tax
rates from flows of incomes, royalties and
dividends. But income from certain forms
of business activity do not garner treaty benefits. For example, a U.S. developer may be
able to credit income taxes paid to Mexico
from the gain of the sale of real property on
the U.S. return. But the tax rates are different in the two nations. As a result, the
American firm will still have to pay a different tax rate. If the effective tax rate in one
country is 35 percent but in the home country the top rate is 28 percent, the business
owner may have to pay the difference to his
country’s government. Also, each country
treats depreciation and realized income differently, which results in a lot of mismatches in the amount of income you report.
PATRICK W. MARTIN is a partner in the San Diego law offices
of Procopio, Cory, Hargreaves & Savitch LLP. Reach him at (619)
515-3230 or [email protected].
