As new offshore markets evolve, the many intricacies of these foreign tax jurisdictions come into play. When coupling unfamiliar offshore tax rules with U.S. tax laws, there are certain crucial strategies to consider before, during and following the establishment or acquisition of a foreign business.
“In order to maximize your inter-company relationships and minimize your global tax, you need to keep these rules in mind as you plan and set up your structure,” says partner Jon Davies of Armanino McKenna LLP.
Smart Business recently spoke with Davies about how U.S. companies planning an offshore move can safely navigate through foreign tax jurisdictions and minimize their overall effective tax rate in our ever-expanding global economy.
When planning a move offshore, what are the first steps?
The main consideration when a U.S. company expands overseas is an issue called permanent establishment or taxable presence in the foreign jurisdiction. This is defined either by the local tax rules in that jurisdiction or by an applicable treaty between the U.S. and that country.
One way to create permanent establishment is when you have a salesperson operating in the foreign jurisdiction, negotiating and concluding contracts on behalf of the U.S. company. Another test is when a company is providing pre- or post-sale service or support or other types of personal services in that jurisdiction that would theoretically be liable for compensation. These are general rules that should be confirmed in each country.
What is the process once permanent establishment is confirmed?
At this point, you need to determine the most beneficial entity to set up to define that presence. Generally, this will be a branch or a subsidiary (corporation) in the local jurisdiction. Now it becomes a decision matrix. You’ll need to determine how to compensate this inter-company relationship whether it’s on a cost-plus basis, a percent of sales revenue from those activities, or one of a variety of transfer-pricing methodologies.
What if business activities do not merit permanent establishment?
Once you’ve analyzed the activities to be performed and determined that they are not going to create a permanent establishment because you’re just doing sales solicitation or product demos, for example then you must decide what kind of non-taxable presence you need to register, if any. In some jurisdictions, you need only register as an employer for that employee and submit the proper payroll filings. Other jurisdictions may require the establishment of what’s called a ‘rep office’ or representative/liaison office.
Should businesses utilize a tax professional in each foreign jurisdiction?
I always liaise with a tax expert in each country to make sure we’re not running afoul of some intricate rule. Accounting firms often have networks they can tap, and experienced consultants usually develop a large personal contact network they can call upon. Companies should contact their U.S. tax adviser, who can provide a proven reference.
What countries offer the most favorable tax environments to U.S. companies?
At this time, many countries have ‘tax holiday’ programs, where you don’t pay tax for a specified time period. China, for example, has certain jurisdictions and economic zones where you may pay zero tax for a few years, then 50 percent of a reduced tax rate for a few more years, and then you move into the reduced tax rate. Other countries are offering tax credits and incentive tax rates if you’re conducting research-and-development activities in certain jurisdictions.
Keep in mind that locating in a foreign jurisdiction should be based on business reasons not because of any individual tax benefit. Once you’ve selected the optimal country, you must also find the most beneficial economic zone within that jurisdiction.
What factors may inhibit offshore business?
The U.S. tax is on a worldwide basis, which is different than many other foreign jurisdictions. The U.S. wants to tax you on all your income everywhere.
Controlled Foreign Corporations (CFCs) are foreign companies controlled by U.S. shareholders. CFCs must operate under very strict rules about how to treat the income they receive. Even though a foreign corporation earns it, the revenue could be taxable in the U.S.
As CFCs develop their international structure, they must keep in mind the type of income that a particular jurisdiction or subsidiary is going to receive and ensure that it’s not going to be treated as deemed dividends or Subpart F income under these CFC rules.
JON DAVIES is an international tax partner with Armanino McKenna LLP in San Jose. Reach him at (408) 200-6411 or firstname.lastname@example.org. For general information, phone (925) 790-2600.