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 email
him at rbrown@alpern.com
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