As your company experiences increasing global commercialization of products, services and technologies, you may face new tax challenges and uncertainties.
“Even the smallest of companies are experiencing some interaction with global suppliers or customers,” says George Koutouras, partner, international and transaction tax, at Moss Adams. “So that means they have the need to consider certain tax aspects associated with global transactions, on one end of the supply chain or the other.”
With a U.S. tax system based on global income, it may make sense for a company — transforming from predominantly domestic to global — to keep earnings offshore to reinvest in new growth for foreign jurisdiction subsidiaries, as opposed to taking U.S.-sourced capital and committing it to offshore operations, he says. However, you must have an economic or legal justification to organize your business that way, as solely tax-motivated transactions are not available in today’s environment.
Smart Business spoke with Koutouras about businesses experiencing increasing growth globally and the potential tax problems.
When migrating capital offshore, why are bank debt covenants important?
When a company decides to go offshore, setting up operations or buying facilities, the first question is not what does that do from a tax perspective, but what are the restrictions on your bank covenants? Lenders may place restrictions on a company’s ability to use lent funds offshore, recognizing the difficulty associated with returning that capital to the U.S.
Review your bank’s financing restrictions. If they limit your ability to migrate cash or capital, determine if you can re-negotiate some of the bank notes, which is not always easy. A company may need to replace certain financing with other debt financing — it’s not a matter to be taken lightly.
Ultimately, whenever sending capital offshore, businesses and their advisers need to understand the intended end result. Do they need to repatriate it at some point to service debt, or do they intend to keep that cash offshore indefinitely to finance offshore growth? The answers will influence the structure that is created from the outset.
How seriously should a company consider local financing options?
If a company migrates some activities offshore, you might need to obtain local financing to expand operations. However, certain jurisdictions, particularly in Europe, are experiencing a credit crisis and, as a result, bank financing is not readily available. Without local financing, question whether there is any ability to service U.S. bank debt, or will you need a mechanism for intercompany financing? Often cash-rich companies use intercompany loans to more freely transfer extra cash between jurisdictions.
But an inevitable hurdle with related-party transactions is the need for a secondary analysis to ensure those transactions are at arms length. Otherwise, the jurisdictions involved, such as the U.S. and Ireland, may attempt to re-characterize or re-price payments to be more consistent with market turns, creating some unanticipated tax consequences.
What intellectual property (IP) will you need within a foreign region?
IP is a relatively broad category of assets that not only consists of patents and trademarks but can also include know-how and processes, and companies should match the commercialization of IP with the development of the IP.
Often businesses take U.S.-developed IP and parse it up among various global commercial centers. However, if IP is being sold in Europe, there may be a need to manipulate or develop that IP in a European-centric way. Companies should identify centers of activity for offshore endeavors, including the development of IP. Areas, such as Ireland for Europe and Singapore for Asia, have a skilled work force, good technology infrastructure for research and development, and a relatively low tax rate when compared to the U.S.
IP is an area where the U.S. is vigilant about establishing policies to restrict companies’ ability to migrate assets offshore, so outright sales of IP offshore aren’t without their accompanying tax costs. Often, property, including IP, in its earliest stages of development and/or recently purchased is the easiest to convey offshore without the inclusion of taxes. To the extent IP and other U.S.-owned assets are needed offshore, consider both sides of related-party pricing to avoid unsupportable accumulations of income or loss in the relevant jurisdictions.
How should you quantify the support needed from domestic management, sales force, technical help or home office systems?
The cost for headquarter-support services needs to be chargebacked by the offshore entity. Companies that aren’t charging for management services and/or systems that go offshore are vulnerable. For example, the U.S. might assert that the foreign entity should be paying more back to the U.S. for the use of the U.S.-based management, thereby creating more potential U.S. tax income. This is something that needs to be reviewed periodically; the management chargebacks existing today might not be the chargebacks needed in a year’s time.
What tax considerations are important for how you sell goods within a region?
Pay attention to how your company conducts sales within the jurisdiction. Sending your domestic sales force into a foreign country will extend the taxable presence to that other jurisdiction. To avoid that, a company can compartmentalize sales by setting up a separate company or using a third-party, such as distributors, already within the country’s marketplace. Another mitigation is to avoid signing sales contracts within market and thereby creating a taxable presence. Ideally, in such cases, all sales are negotiated and executed remotely, and the salesperson is merely demonstrating the product with no authority to sell on behalf of company.
Also, when selling inventory, the placement of property within a jurisdiction could create a taxable presence. The U.S. will tax the income, and the foreign jurisdiction may assert tax liability for sales within its borders, creating the possibility that the same dollar could be taxed twice.
George Koutouras is a partner, international and transaction tax, at Moss Adams. Reach him at (415) 677-8212 or George.Koutouras@mossadams.com.
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When Andrew Dorn, Industry Leader, Information Intensive Business, Acxiom Corporation, was recently researching the top manufacturers in the United States, one topic kept coming up — the strong growth expectations focused on the world's emerging markets. With the economies of the U.S. and Europe in flux, Dorn felt that, now more than ever, manufacturers need to be attentive to those emerging markets.
"The world is now flat," says Dorn. "Competition comes from everywhere, so manufacturers need to be everywhere."
Because of that, Acxiom has partnered with Smart Business to present a special one-hour webinar: "Driving Global Sales for Manufacturers: Why global growth for manufacturers is more important than ever."
During the webinar — on Wednesday, September 19 at 1:00pm EST — we will discuss why global sales for manufacturers is critical, what factors should be considered in developing or refining the international strategy, and, finally, present a roadmap that can be employed to optimize chances for success.
Featured panelists will be Zia Daniell Wigder, Vice President and Research Director, Forrester Research; Jennifer Barrett Glasgow, Global Privacy and Public Policy Executive, Acxiom; and Michael Biwer, Managing Director, Acxiom.
"As you enter the global market, it is imperative you understand the privacy laws in each country as they are quite complex and some are very stringent, for example, having criminal penalties for some violations," says Barrett Glasgow.
Other topics to be discussed include:
- How to determine which countries to enter and what data to gather to understand regional customer requirements
- Recommended approaches to building country-specific strategies that can help facilitate smooth transitions, lowest possible cost-of-entry, and consistent performance
- Considerations for navigating the complex web of country-specific data protection and privacy laws companies must adhere to in their efforts to connect with customers and prospects
- Best practices used by leading companies that have successfully entered new markets
"The U.S. and European economies are still recovering and the balance of growth is constantly shifting," says Dorn. "For example, China and Brazil have been experiencing strong growth. They are encountering a maturity curve, but that doesn't lessen the importance of the issue — manufacturers need to be diversified and have a presence in all major world markets."
The webinar, "Driving Global Sales for Manufacturers: Why global growth for manufacturers is more important than ever" will be held at 1:00 pm EST on Wednesday, September 19.
Establishing a foreign subsidiary may have lucrative business advantages, but if you’ve decided to pursue this strategy, it’s important to stay informed, plan ahead and follow proper compliance with both U.S. and international requirements. Failing to do so can result in undesired consequences and potential IRS penalties.
To ensure proper compliance domestically and abroad, engage a solid group of advisers in the initial planning stages, says Sonia Agee, partner at Ropers Majeski Kohn & Bentley PC.
“It is critical to have the right team in place,” says Agee. “Generally speaking, that team consists of a U.S. legal counsel, accountancy professionals on both sides of the operations who understand the coordination of the various tax and reporting requirements between the U.S. and foreign jurisdictions, and a foreign counsel who also has the same knowledge and understanding.”
Smart Business spoke with Agee about the steps to take when expanding overseas, and how to maintain compliance with both domestic and foreign regulations.
What initial talking points should business owners discuss with their counsel when they’ve made the decision to expand overseas?
When a business client first comes to us and expresses interest in looking at overseas opportunities, first and foremost we need to get a clear understanding of the goals and strategies for pursuing foreign operations. We assess the specifics of what the company plans to accomplish by expanding overseas, and how it may be different from or impact what they’re doing here in the U.S.
Once the company makes the determination to expand internationally, it is critical to ensure that the new business venture is properly structured overseas. The necessary steps will vary widely depending on the jurisdiction in which the company is looking to operate. In addition to U.S. counsel, it is important to have good counsel overseas who has worked with cross-border issues, because there is often a delicate balancing act to making it work overseas, as well as from a U.S. perspective. Not all forms of entity will work for all ventures, so making sure that the foreign venture is properly structured minimizes liability to the company.
What potential legal landmines exist with foreign subsidiaries?
Once the setup with regard to the actual structure is determined, you must look at the detailed aspects of the company’s operations. The company must coordinate a number of things, including the work force: will it be necessary to hire a foreign work force, or will the company be bringing key individuals from the U.S. or from other parts of the world into that new jurisdiction? In either case, there are both immigration and employment law issues to coordinate in the U.S. as well as from the foreign perspective. For example, if the company plans to replace a local work force by moving overseas, it is imperative to hire employment counsel because, depending on the size of the work force, there may be a number of formal requirements to avoid liabilities.
Additionally, many jurisdictions have varying laws surrounding intellectual property. Some jurisdictions simply don’t provide the same protection that we have in the U.S. in terms of intellectual property rights, so it is important to identify those issues and determine the best way to deal with them.
Finally, the company must be sure that appropriate reporting and compliance is in place. There is a myth that if you earn the money overseas and don’t bring it back to the U.S., you don’t have to report it. The general rule under U.S. tax law is that worldwide income is reportable and taxable in the U.S. If a company is formed as a subsidiary of a U.S. entity, the U.S. entity has a reporting requirement. Conversely, if a company goes overseas and is formed as a ‘sister company’ to the U.S. company (the ownership of the foreign entity mirrors the ownership of the U.S. company) there are still reporting requirements. Not only must the appropriate forms disclosing the existence of the foreign entity be filed each year, but, in addition, all income from the foreign entity likely needs to be reported here in the U.S., either through the U.S. entity or through the shareholders.
If a company has a foreign bank account for the foreign business, and a U.S. person has signature authority over the account, the U.S. person is required to file a reporting form disclosing the existence of that account as well as their authority over it. There is a significant penalty an individual can incur for failure to report; it can be up to a $10,000-per-year penalty for not reporting a foreign account, so it’s very important if you are looking to go overseas that those reporting requirements are dealt with each year. If they’re not, every year can carry its own penalty and fine.
What other issues should you consider to get the most benefit from a foreign subsidiary?
Another question to ask is ‘Can the entity here in the United States have a subsidiary overseas?’ In most instances, the answer is yes, but a U.S. company does not want to inadvertently forfeit U.S. tax benefits by having an entity formed overseas that may not work with the U.S. requirements — for example, S corporations may only have qualified S subsidiaries. A foreign entity may not comply with the requirements and the S status benefits would be lost.
Again, working with foreign counsel to ensure the form of the foreign entity chosen does not present any problems for the intended purposes is extremely important, as there may be other limitations overseas. For example, a company may not be able to have a direct foreign subsidiary due to specific limitations on ownership imposed by the foreign jurisdiction. Each jurisdiction has its own requirements that need to be understood in the context of the proposed foreign operations before making any decisions.
Sonia Agee is a partner with Ropers Majeski Kohn & Bentley PC. Reach her at (408) 947-4889 or firstname.lastname@example.org.