The U.S. has a three-tiered system of taxation at the federal, state, and local levels. The myriad laws at each level create compliance challenges, especially for foreign companies expanding into the U.S.
The following checklist highlights key considerations when launching U.S. operations.
☐ Business Structure
In most cases, foreign companies expanding into the U.S. will establish a U.S. subsidiary as a C corporation that is a separate legal entity. There are some advantages for certain businesses to set up pass-through entities. However, for this checklist we will focus on the more common corporate structure.
- Consult an attorney for entity creation, articles of organization, operating agreement, contracts, IP protection, web domain and trademark registration.
- Select a tax year. Likely, it will be the same fiscal year as the foreign parent.
- Apply for a U.S. Employer Identification Number (EIN).
- Consider business insurance.
- Another decision is whether to capitalize the U.S. venture with debt, equity, or a combination of the two.
- From the U.S. perspective, debt is preferable because interest payments are deductible and debt principal payments are tax-free. In contrast, partial payment of equity may result in dividend treatment. Dividends are not deductible. However, other considerations come into play:
- What is home country treatment of interest versus dividends?
- Based on thin capitalization case law, the IRS may recharacterize debt to equity.
- S. earnings stripping rules may require a deferral of certain interest expense if debt to equity ratio exceeds 1.5 to 1.
- Certain tax codes restrict the deduction of interest expense.
☐ Repatriation of Profits
- The foreign parent has several ways to repatriate the profits of the U.S. subsidiary.
- Royalties for parent-owned intellectual property
- Management service fees
- Inbound sales
- Interest and dividends
☐ U.S. Income Tax Treaties
- The amount of U.S. tax required to be withheld on payments to the foreign parent of interest, dividends, and royalties depends on whether there is a tax treaty with the parent’s home country.
- In general, the IRS default withholding on interest, dividends, and royalties paid to a foreign person is 30%. However, a treaty can reduce the tax withholding for interest and dividends. Furthermore, royalties paid to a foreign parent in a treaty country are typically taxed only in that foreign country.
☐ Transfer Pricing
- Transactions between the foreign parent and its U.S. subsidiary are governed by the arm’s length standard imposed by U.S. tax law and the home country regulations. A study to support the pricing is advisable.
☐ Federal Income Tax
- The federal government imposes a corporate tax rate of 21% on worldwide earnings of domestic corporations.
- In general, the mere fact that a foreign company owns a U.S. subsidiary does not create a U.S. filing requirement for the foreign parent. In order to avoid US tax filings, the foreign parent can limit certain activities within the U.S.
☐ Federal Tax Credits and Incentives
- The federal government provides valuable credits and incentives. One of these is the research and development credit.
☐ State and Local Income tax
- Most states (but not all) and some municipalities impose an income tax if the business has nexus in the state.
- Nexus is generally defined as having a sufficient connection with a state. This connection can be based on economic activity even if there is no physical presence in the state. Careful study of each state’s requirements is necessary.
- Many states also levy a franchise tax instead of, or in addition to, an income tax. Franchise taxes are levied on net worth, equity, or factors other than net income.
☐ State Tax Credits and Incentive
- Economic development agencies are keen on businesses moving into their region to create jobs and a tax base. Statutory or discretionary incentives are available for tax exemptions as you negotiate the subsidiary’s location.
☐ Payroll Taxes
- Income taxes are withheld from an employee’s gross pay at both the federal and state level (assuming the state has individual income tax), and sometimes at the city level.
- Employers are also required to pay social security and Medicare taxes as well as withhold these taxes from employees.
- Federal and state unemployment taxes are paid by employers.
- A professional payroll service is recommended as the government is unforgiving in imposing penalties for any missteps.
☐ Sales and Use Taxes
- The U.S. does not levy a Value Added Tax (VAT). Instead, there is a sales tax. This is a transactional tax imposed by state and local governments on the consumers related to the purchase of tangible personal property and certain services.
- Sales tax is collected at the point of sale to the end-users.
- Nexus is the necessary connection that a retailer has to a taxing jurisdiction to be required to collect and remit sales tax.
- Beware that the nexus for income tax and sales tax can be different for each state.
- A complementary tax to the sales tax is the “use tax.” Generally, this is assessed on otherwise taxable sales when the vendor does not collect the tax.
☐ Business Personal Property Taxes and Local License Fees
- Many state and local governments impose a tax on the value of business personal property tax within their jurisdiction.
- Certain counties and cities may impose a local license tax or fee.
Despite the tangle of laws and taxing jurisdictions within the U.S., careful planning can lead to a smooth expansion of business operations.
The potential rewards for expanding business operations in America are large, but so are the penalties for noncompliance with the tax code and other regulations. PBMares can navigate the expansion to secure your footing in the U.S. while avoiding tax pitfalls. Contact your PBMares representative or a member of the International Tax team for assistance.