As technology makes doing business overseas an option for more and more companies, American firms are exploring their international options.
Once a business decides to open operations in one or more countries outside the United States, the tax hurdles crop up and executives are faced with complicated decisions concerning acquisitions, hiring employees, tax structure and transfer pricing. Getting it right is critical to protect a business from multiple layers of taxes and fines as both the federal government and foreign governments focus on enforcing complex international tax laws, says Doug Eckert, member and international tax practice leader, Brown Smith Wallace LLC, St. Louis, Mo.
“U.S. businesses with international operations should develop a tax strategy in conjunction with international expansion to minimize tax costs from the beginning,” Eckert says.
Smart Business spoke with Eckert about what businesses should consider when expanding their operations beyond U.S. borders.
What should a business know when venturing beyond U.S. borders for the first time?
The greatest challenges a company faces are personnel hiring outside of the U.S. where human resource laws are significantly different, managing foreign customer expectations and managing cross-border tax consequences, including transfer pricing, an area where significant penalties can arise for companies that do not transfer goods at ‘arm’s length pricing.’
The initial business plan needs to take into account each of these areas.
What key tax issues do companies face when expanding internationally?
Once a company makes the decision to expand outside of the U.S., it first has to determine how it will distribute its products or services, and whether to use third-party distributors or its own employees to manage its foreign operations.
The initial determination of whether a U.S. company needs its own foreign subsidiary is often determined by its customers. This usually occurs when the customer requests that import taxes, duties and VAT (value added tax) are managed by the U.S. seller. At this point, a foreign subsidiary is generally required to manage these taxes within the local country.
Then several key questions arise. Should the company be a corporation or branch (income or loss is subject to immediate U.S. taxation) of the U.S. parent? How should the company be funded, whether through debt or equity? How can profits be transferred tax efficiently to the U.S. parent?
The U.S. has the second-highest corporate tax rate in the world. Careful international tax planning is required in order to repatriate overseas profits to the U.S. to avoid paying the disparity between the U.S. and foreign tax rates, or even more. Governments are ready and willing to take your money if you don’t plan carefully.
What challenges does a business face when making an international acquisition?
The ultimate challenge is how to repatriate earnings to the U.S. to service the acquisition debt in a tax-efficient manner and avoid paying the incremental U.S. tax in the process. This process is managed by setting up a tax-efficient acquisition structure and, in many cases, pushing acquisition debt into the overseas operations. Managing foreign currency risk as part of this process is also an important consideration.
An example of what not to do is to enter into a structure in which cross-border payments, dividends and interest will be subject to withholding taxes. In some situations, this could cause the overall rate of tax to exceed the U.S. statutory tax rate of 35 percent. To avoid this, it is important to design an acquisition structure that will allow cash to be flexibly managed within the structure in a tax-efficient manner.
What new legislation could impact a company’s international tax position in the next year?
In 2010, Congress enacted several new tax laws that impede the ability of U.S. multinational corporations to credit foreign taxes paid. The most significant of these laws are the ‘foreign tax credit splitter rules’ and the ‘covered asset acquisition rules.’
The foreign tax credit splitter rules preclude foreign taxes from offsetting U.S. taxes until the related foreign earnings are subject to U.S. taxation. The covered asset acquisition rules deny U.S. companies from taking a portion of their foreign tax credits in cases where the value of the foreign assets is stepped up to fair market value. This generally occurs in the context of an acquisition.
Both of these rules narrow the options available to U.S. corporations to avoid paying the difference between foreign tax rates and the U.S. tax rate when repatriating funds to the U.S.
Essentially, these rules will likely increase U.S.-based multinationals’ U.S. tax liability. Given this legislation and the current complexity of U.S. international tax law, companies should talk with a professional to understand how these tax rules interplay.
Ultimately, all these rules come down to a large modeling exercise to minimize your global taxes.
Doug Eckert is a member and international tax practice leader at Brown Smith Wallace. Reach him at (314) 983-1268 or firstname.lastname@example.org.