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Doing Business Outside the U.S.

Your business is doing well and you are thinking of expanding your scope of operations abroad. As with any business decision, due diligence must be performed. What are some of the major issues and opportunities involved? This article gives you a brief overview of the necessary thought process and discusses some of the tax implications of expanding outside the United States.

Do I need a new business entity?

The issues involved in this decision are legal, financial and tax oriented. For example, the business proposition may require the cooperation of locals who will want to participate in ownership. If you plan to have local partners in several countries, having a separate entity in each may make accounting and governance issues much simpler.

Another point is that some countries require local participation under their relevant commercial law (perhaps for certain types of activities or generally if you want to have access to foreign exchange privileges). Also, in many countries there are business or tax advantages for locally established entities (whether or not they have local ownership). Beyond the types of business entities we are all familiar with (i.e., corporations, partnerships and sole proprietorships), foreign countries provide a bewildering array of possibilities to consider. Do not assume that the foreign country treatment of a particular entity is the same as the U.S. treatment. Some important issues to consider include:

• How expensive is the local entity to establish and maintain?
• How does the foreign country treat non-country (e.g., U.S.) owners?
• Does the entity type insulate owners fully or partially from debts or liabilities of the entity?
• How is the entity taxed?
• Would the owners have any local country tax liability on earnings of the entity?
• How would the foreign country tax distributions to owners?

This list is by no means complete and will change depending on the business plan. Be aware that foreign tax and business law may be significantly different from U.S. laws with which you are familiar.

How will business activities in the new country be taxed?

If the array of types of business entities is bewildering, the various types of taxes that may apply and the laws under which they are administered are even more so.

In general, foreign countries have more and different taxes with which U.S. persons might be familiar. In addition to income taxes applicable to entities and individuals, foreign countries might have document recording taxes (prevalent in Europe and South America), transaction taxes (e.g., general sales tax in Canada and VAT in Europe), import (i.e., customs) duties, property taxes (both general and specific) and taxes on personal net worth. Unlike the U.S., many foreign countries have different income tax rates and calculation models for different types of income producing activities (i.e., a “schedule” approach instead of an overall taxable income approach).

The first question to ask is whether or not the new country has an income tax treaty with the U.S. because this may overrule some local rules. The second question to address is how the new country will tax the business entity (either your current U.S. entity or the local one established to do business in the new country)? The third question is how are U.S. employees who work in the new country taxed?

Even a simple activity such as shipping products to a new country or providing services to customers in a new country (without sending people there) may expose you to new tax liabilities. Finally, the tax structure of a given country may be very beneficial for certain activities and not others. For example, Luxembourg has very favorable rules for taxation of holding companies and finance entities where the actual business activities are conducted elsewhere. Ireland is another example that may have the most favorable income tax rate applicable to business entities in all of Europe (12.5% currently).

How will U.S. employees who work in the new country be affected?

Whether they are working for the U.S. entity or a local country entity, your U.S. employees working in the new country need a U.S. passport, a visa to legally enter the new country, and perhaps legal permission from the government to work there. It is important to obtain competent local legal advice on these points, but the initial determinations can usually be made with help from the new country’s U.S. embassy or consulate.

Foreign countries that have income tax laws applicable to individuals generally apply them to compensation earned by U.S. persons from services performed in that country. There may be certain exceptions based upon length of stay, amount earned, and who the employer is. Again, the rules may depend on the terms of any applicable U.S. income tax treaty. Many foreign countries also have social insurance systems supported by employment taxes (similar to FICA and FUTA, but often much higher). When and how these apply vary from country to country. Again there may be an applicable U.S. treaty (called a totalization agreement), but there are far fewer of these than income tax treaties.

Another point to note is that U.S. tax law provides special rules applicable to U.S. persons working abroad to prevent double taxation (for example, the foreign tax credit) or to reduce the overall cost of foreign employment (for example, the foreign earned income exclusion).

As you can see from the above, the list of things to think about can be quite long and the analysis can be quite complicated. Besides tax-related matters, living conditions (such as housing, schools and transportation) need to be addressed as well as language and cultural differences (which should be ignored at the employer’s peril). To take full advantage of the opportunities that exist abroad, be sure to consult with international business advisors who have experience with multi-national enterprises.

For more information, contact Robert M. Brown, CPA, Director of International Taxation Services, at 412.281.2501, ext. 465 or rbrown@alpern.com

 

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