How to understand tax implications of doing business overseas

Richard J. Nelson, CPA, director, Tax Strategies, Kreischer Miller

Richard J. Nelson, CPA, director, Tax Strategies, Kreischer Miller

It used to be that only very large companies were doing business overseas. As more small and midsize companies enter the international marketplace, they must learn how to navigate tax laws related to conducting business in foreign countries.

“These tax laws are often broad and complex, and companies need to know how to minimize their combined taxes,” says Richard J. Nelson, CPA, director of Tax Strategies at Kreischer Miller.

Smart Business spoke with Nelson about what companies need to consider and how to manage the tax implications of doing business overseas.

What do companies need to consider in terms of taxes related to international business?

The first, and most important, decision is what to do regarding profits and cash from overseas operations. Are you planning to bring profits back to the United States right away or will you seek a deferral strategy that will leave cash and profits overseas for the time being? The answer to that question determines how overseas operations are structured.

A deferral structure is preferable when you want to keep profits offshore for a significant time and the foreign tax rate is lower than the U.S. tax rate. In order to defer U.S. tax, the foreign entity must be treated as a corporation for U.S. tax purposes. The goal is to move as much income as possible to this entity, and to defer U.S. tax until earnings are brought back here.

What problems do companies encounter with the deferral strategy?

Some pitfalls include matching of foreign tax credits, Subpart F rules and transfer pricing rules.

Proper planning is needed to ensure foreign taxes paid are credited to offset U.S. taxes. Subpart F rules, if applicable, make foreign profits taxable in the U.S., even if the earnings are not repatriated. Poor planning in these two areas could result in paying a higher overall effective tax rate on the same income.

Transfer pricing rules are designed to ensure that the transfer of goods from the U.S. company to the foreign company are priced fairly so the U.S. collects its fair share of taxes on the profit. If the Internal Revenue Service challenges your pricing, you could face significant penalties.

Does a non-deferral strategy pose pitfalls as well?

In a non-deferral strategy, the tax implications are not nearly as complicated. Generally, the foreign company is established as a ‘pass through’ entity, or you can check a box to have it treated as a disregarded entity or pass through entity. With this structure, the U.S. taxes the income of the foreign corporation and foreign tax credits are available to offset any U.S. tax on current profits. There are no additional U.S. taxes when the money is repatriated.

Under this scenario, you don’t need to be concerned about transfer pricing rules, at least from a U.S. perspective, or Subpart F rules. This structure provides the most flexibility and is well suited to U.S. companies that are S corporations with overseas operations.

Are there tax incentives for a U.S. company doing business overseas?

If you are selling products overseas that are manufactured in the U.S., you may be able to take advantage of an Interest-Charge Domestic International Sales Corporation (IC-DISC). You set up a separate corporation that makes an IC-DISC election and is, by law, exempt from federal income tax. A commission agreement is entered into between the related exporter and the IC-DISC. The related exporter pays the commission to the IC-DISC, which gets a 35 percent tax deduction. The IC-DISC then pays the commission to its shareholders, who are individuals, as a qualified dividend, which is taxed at 20 percent. The overall savings is 15 percent.

Can companies manage the various tax scenarios internally?

Because of the many complexities involved in doing business internationally, there is a lot of expertise required in planning a strategy to minimize the company’s overall effective tax rate. Seeking competent advice is crucial to avoid the many pitfalls that you may encounter when venturing overseas.

Richard J. Nelson, CPA, is a director, Tax Strategies, at Kreischer Miller. Reach him at (215) 441-4600 or [email protected]

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How to cover your overseas business exposures

Richard B. Hite, CEO, SeibertKeck Insurance Agency

An employee is critically hurt in a taxicab accident while on business in China. He had to be stabilized at the scene, flown to the coast and then to Hong Kong. Two operations and two months later, he is sent back to the U.S. on a private charter plane with two nurses and a doctor. The repatriation trip alone costs $140,000, which he would have had to pay had he not had foreign insurance.

Richard B. Hite, CEO of SeibertKeck Insurance Agency, says domestic U.S. policies only cover incidents occurring in the U.S., Canada, Puerto Rico or any U.S. possession.

“A standard domestic insurance policy doesn’t insure against foreign business exposure in general,” he says. “As long as your company has goods, services or people going overseas, you’re going to need foreign

Smart Business spoke with Hite about how to get the most out of your foreign package coverage.

What are the characteristics of international insurance?

There are a number of scenarios where foreign insurance is necessary. For example, a salesperson at an international conference demonstrating a product causes bodily injury or property damage. Maybe you’re exporting products and have a product failure — a propane tank explodes and kills 20 people. If sued, your domestic policy does not respond to lawsuits outside of the U.S. and Canada.

Under a foreign package policy, there are five types of coverage. They are:

  • General liability — Covers public liability, including product liability.
  • Property coverage — Protection for laptop computers, sales samples, personal property at trade shows, etc.
  • Foreign voluntary workers’ compensation — Provides employees workers’ compensation and covers medical costs and loss of earnings as if the employee was hurt in Ohio or whatever the state of domicile. With 24/7 coverage, it also provides medical assistance services and repatriation expenses to get an employee to the U.S., including immediate family traveling with him or her or allowing family to fly to the foreign location where the employee is being treated.
  • Accidental death and dismemberment (AD&D) coverage.
  • Automobile liability — When an employee rents a car, there is certain compulsory insurance coverage in that country, but this provides excess liability.

Other types of foreign insurance exposure include kidnap and ransom, business interruption, crime and ocean cargo for when you’re responsible for your export shipment of goods in a container until it arrives.

How has foreign insurance changed to better serve small and mid-sized businesses?

With globalization and international trade agreements, even a small company could be distributing products abroad, but many small and mid-sized businesses don’t realize the protection needed. Insurance companies have different coverage levels, but usually a minimum premium with all five basic types of coverage runs an affordable $1,500 to $2,500 per year.

How do you decide which coverage and options or limits to buy?

Analyze the exposure — what employees, goods or services are doing and where they are going. Public liability and foreign workers’ compensation are necessary, but property and automobile depend on the circumstances. Property could be worth it if you have sales samples or laptop computers going abroad, but your employee might not be driving anywhere. Additionally, the AD&D for many mid-sized business is already an international 24/7 policy, so there could be a duplication of coverage. The insurance company takes a census of the number of people, where they are going and for how long, and then creates different rates for different risks.

Many policies exclude countries not aligned with U.S. foreign policy, such as Syria, Iraq, Iran and now, Mexico. To get around it, underwriters want to know the finite trip details. For example, Monterrey, Mexico, is a medium risk, while Mexico City is very hazardous and has become its own cottage industry considering the high incidence of kidnap and ransom occurring there. In general, the insurance company writes a blanket policy for all countries, excluding certain ones, and then underwrites exceptions on a per-trip basis.

What’s the difference between buying international insurance in the U.S. or local insurance in the foreign country?

If you write a policy in the U.S., called a nonadmitted basis, most countries accept it. However, some foreign countries require a domicile insurance company and a broker to write the policy as a form of protectionism. Therefore, big companies — Travelers, Chartis and Chubb — have foreign divisions writing policies, called an admitted basis. You might need a combination of nonadmitted and admitted insurance to ensure the proper coverage.

It’s almost always advantageous to buy U.S. coverage rather than admitted coverage in the country itself. U.S. coverage provides compulsory insurance on a broader basis and uses a U.S. company and adjuster, with the cost not necessarily more expensive.

What steps should employers take if something happens to an employee or property abroad?

The planning should be part of your disaster preparedness program. Insurance companies have emergency response teams globally who speak the local languages. As part of the service, you reach out to these key contact people if there’s a problem. They also know what steps to take to get the best medical care. For example, in Shanghai, China, hospitals won’t operate unless they know they will be

Additionally, the insurance company will set up a website to be checked throughout the trip. It gives tips on how to travel, how to dress, what areas to avoid, and a security and weather report. It helps employees blend in and act accordingly, which also prevents them from becoming a target.

Richard B. Hite is the CEO of SeibertKeck Insurance Agency. Reach him at (330) 865-6573 or [email protected]

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Pfizer settles foreign bribery case with U.S. government

NEW YORK, Tue Aug 7, 2012 – Pfizer Inc. has agreed to pay $60.2 million to settle a U.S. government probe of the drug maker’s alleged use of illegal payments to win business overseas, according to the U.S. Securities and Exchange Commission.

The settlement, made public on Tuesday, is part of a broad crackdown on bribery by multinational companies in foreign countries that has affected several of the world’s top pharmaceutical companies.

According to an SEC complaint, filed in U.S. District Court for the District of Columbia, Pfizer’s misconduct dates to 2001. Employees of Pfizer subsidiaries bribed foreign officials to use Pfizer products and boost prescriptions, the complaint said.

The improper payments were made to officials in Russia, Bulgaria, Croatia, Kazakhstan, Serbia, Czech Republic, China and Italy.

The 1977 Foreign Corrupt Practices Act makes it illegal for U.S. companies and foreign firms whose stock is traded in the United States to bribe government officials in foreign countries.

Separately, the SEC also charged Wyeth, which Pfizer acquired in 2009, with similar violations. Pfizer and Wyeth agreed to separate settlements in which they will pay a total more than $45 million.

In a parallel action, the Justice Department said a Pfizer indirect subsidiary, Pfizer H.C.P. Corp., had agreed to pay a $15 million penalty to resolve a department investigation of alleged violations.

Fisker CEO revamps business plan amid Karma woes

NEW YORK, Wed Apr 4, 2012 – Fisker Automotive, a maker of plug-in hybrid sports cars, may build its second model outside of the United States if federal funds intended to pay for the vehicle’s production fall through, the company’s chief executive said on Tuesday.

Earlier this year, the U.S. Department of Energy froze a $529 million loan awarded to Fisker in 2009 as part of an Obama administration program to spur advanced vehicle development.

The bulk of that loan was slated to help Fisker build the new model, called the Atlantic, at a former General Motors Co. factory in Wilmington, Delaware.

“We’re going to launch this car with or without the DOE,” said CEO Tom LaSorda during a media event ahead of the New York auto show. “We’re proceeding where the best cost will be. We’re looking for alternative options to the U.S., of course.”

LaSorda said Fisker would make a decision on where to build the Atlantic by the end of the summer, when production of the model was initially expected to begin. That will now be pushed back.

LaSorda and other Fisker executives, including founder Henrik Fisker, were in New York to showcase a concept version of the Atlantic, previously known as Project NINA.

Fisker is still renegotiating the terms of the DOE loan. It is also is seeking private financing and considering a high-yield debt deal. LaSorda added that Fisker was also interested in strategic partnerships.

The Delaware plant, which can build up to 100,000 cars, is still the “primary” choice, but here the Atlantic is built depends in part on who invests in the company, LaSorda said.

“One thing we need is investments,” said LaSorda, a former chief executive of Chrysler Group, said.

“There’s a lot of interested parties outside the U.S. The investment will certainly influence us in where we might go,” he said, without elaborating.

Avon under SEC investigation for bribery charges; shares drop

NEW YORK ― U.S. regulators are formally investigating whether Avon broke bribery laws overseas, and the cosmetics company said it was again reassessing its strategy after quarterly profit fell far short of expectations.

Shares of Avon fell as much as 19.6 percent on Thursday, as analysts questioned whether the company can come up with a turnaround plan as quickly as it expects to.

Analysts, as they have in past quarters, again took Chairman and Chief Executive Andrea Jung to task during the company’s quarterly conference call.

“Why should investors believe management and the board have any control over the business at this point?” asked Stifel Nicolaus’ Mark Astrachan, who downgraded Avon to “hold.”

“Look, the buck stops with me,” replied Jung, who has been CEO since 1999 and chairman since 2001.

U.S. regulators also subpoenaed Avon Products Inc over its contact with analysts and others as part of an investigation related to fair disclosure under Regulation FD.

Under Jung, Avon has turned in poor performances in Brazil and Russia, poured tens of millions of dollars into its international bribery investigation and struggled to stem declines in a sluggish U.S. market.

Avon, which has been celebrating its 125th anniversary with celebrity-studded events throughout the year, now plans to assess long-range business plans and give an update at a meeting during the first quarter of 2012.

“It strikes me that you guys are so totally screwed up, in so many ways, the change has to be radical,” said Citigroup analyst Wendy Nicholson, who noted that a first-quarter meeting may not give Avon enough time for a comprehensive review.

Another potential red flag is that Avon cannot fully fund its dividend with free cash flow. The payout was raised to a quarterly rate of 23 cents per share earlier this year.

Turning overseas legal disputes into smart business

William Walker, Greenberg Glusker Fields Claman & Machtinger LLP

Smart Business spoke to William Walker at Greenberg Glusker Fields Claman & Machtinger LLP about how to navigate the legal system in other countries and use it to your advantage.

I have been called many times by clients located in the United States who have been sued overseas. In addition to being unhappy about being sued at all, the prospect of litigating in a foreign country can be intimidating and daunting. Fears of the unknown, and of being “home towned,” are common, and understandable, initial reactions. In some fora, they are very real problems.

However, foreign litigation is often nothing to fear. In fact, depending on the country, foreign courts can often be much better fora for litigation than U.S. courts, even for U.S. companies. There are many reasons why.

First, the speed and efficiency of foreign courts can be impressive. At Greenberg Glusker, and at my previous firm, I worked on many litigations in Europe, particularly in Germany. Lawsuits there are often completed, from the filing of the complaint to the date of judgment, in only six to eight months.

And, the process of getting to judgment involves much less expense. In Germany, there is no pre-trial discovery. That means no depositions, no interrogatories, no requests for admissions. The parties do not produce their documents to each other. There is no “e-discovery,” and thus no related “e-vendor” expenses. Although a party may move the court to order an opponent to produce documents, such motions are rarely granted.

Instead, the parties proceed with the information they have in their possession and use it in their complaint, answer and any replies to set forth the legal and factual arguments as to why they should win. Witnesses whose testimony is relevant to particular arguments are also listed. If the parties think that expert witness opinions would support a claim or defense, they also state that in the complaint or answer. It is up to the court to decide whether it wants an expert opinion at all. If it does, it will appoint a neutral expert.

Once those pleadings are filed, the court sets a hearing date and time. Typically, one hour is allocated. At that hearing, the merits of the case will be considered. The courts often do not hear witnesses. Instead, they rely on the written submissions discussed above, and on the oral arguments of counsel at the hearing. Frequently, the court issues a judgment a few weeks after the hearing.

That sometimes takes American parties by surprise. Familiar with the American system, in which the initial hearing is a simple status conference, they fail to include all of their arguments in their papers and are unprepared to fully argue the case at the hearing, with negative consequences.

But with proper advice from counsel with knowledge of both the foreign and U.S. legal systems, those misunderstandings can be avoided and significant tactical and strategic benefits can be obtained.

For example, the absence of pre-trial discovery creates tremendous savings in attorneys’ fees and costs. That is particularly so in the era of “e-discovery,” which in the U.S. leads to substantial attorneys’ fees, disruption to a client’s business, and massive vendor bills that can dwarf the attorneys’ fees.

Juries are not used in the expeditious hearing process described above, which creates further substantial savings of time and money. If a party would rather proceed in front of judges instead of a jury, this is a significant advantage.

Punitive damages are also not available in Germany and in most other civil law countries.

And, perhaps most importantly, a good foreign forum may present excellent opportunities to seize the initiative from litigation opponents and knock them back on their heels, sometimes decisively. A party threatened with litigation in the U.S. can go to court overseas either before being sued in the U.S., or even sometimes after.

U.S. plaintiffs rarely expect to be sued overseas by the defendant. A foreign lawsuit brought by a defendant, or someone who has been threatened with a lawsuit in the U.S., means that the battle will not be fought solely on terrain chosen by the plaintiff.

Even better, the speed of some foreign fora can force the U.S. plaintiff to assert its claims in the foreign forum in the form of counter-claims. That is because if the U.S. plaintiff does not do so, then the U.S. plaintiff runs the risk of a foreign judgment being rendered only for the claims in the defendant’s foreign lawsuit. The defendant can then bring any foreign judgment to the U.S. and move the U.S. court for recognition of the foreign judgment under U.S. law and a ruling that, based on the foreign judgment, the U.S. case is res judicata and should be dismissed. Most U.S. states have statutes that provide for the recognition of foreign judgments, for example, the Uniform Foreign-Country Money Judgments Recognition Act, California Civil Procedure Code Section 1713 et seq.

Strategically, even an adverse foreign judgment might sometimes be preferable to the prospect of defending a lengthy and costly litigation in the U.S. In the event of an adverse foreign judgment, in any res judicata motion brought in the U.S., the U.S. defendant can argue that the plaintiff has already obtained relief through the foreign judgment, and that there is thus no need for the U.S. case to proceed. If the defendant is overseas, a foreign judgment allows the defendant to argue in the foreign court that a later U.S. judgment on the same, or similar, claims should not be enforced in the face of the foreign judgment.

The potential advantages are not limited to defendants. Plaintiffs usually have the same interests in limiting expenses and achieving a quicker result. Sometimes the prospect of lengthy and costly litigation deters plaintiffs from bringing otherwise meritorious claims. In such circumstances, the right foreign forum can provide a good alternative.

This is obviously a very general discussion, and each case has its own complexities. However, I have seen the foreign litigation strategy work many times in seemingly intractable disputes. For parties seeking better alternatives than years of expensive and disruptive litigation in the U.S., litigating overseas can often offer substantial advantages that really are “Smart Business.”

William “Bill” Walker’s practice focuses on representing entertainment companies and domestic and overseas corporations in all aspects of business and commercial litigation, including in California state and federal courts, domestic and international arbitrations, and assisting representation with respect to overseas litigations and transactions, especially in Germany and Greater China. He can be reached at [email protected] or (310) 201-7482.