Tax and Other Considerations When Your Business Expands Outside of the US

The early stages of planning for an international expansion is an exciting time. While the US is an economic powerhouse, access to the global economy opens up significant opportunities for all kinds of businesses. With the right execution, these opportunities can spark game-changing growth. 

International expansion can take many forms: from establishing a sales office across the border in Canada to entering a contract manufacturing relationship in Asia. Every business’ international expansion is distinct and gives rise to a unique set of considerations––tax and otherwise. 

Of course, businesses must comply with local tax laws in the nations they expand into, but there are also compliance requirements here in the US that must be satisfied too. In this overview, we will explore exactly what these considerations look like and highlight the key issues leaders should bear in mind as they prepare for international expansion.

Tax Considerations When Your Business Expands Outside of the US

An international expansion presents a myriad of tax issues: both here at home in the US and in the nation(s) the business is expanding into. Building a tax-efficient strategy demands businesses embrace a proactive approach that enables leaders to fully weigh their options. 

International tax considerations are highly complex. It’s important to partner with advisors with global experience and a network of international service providers that are fully equipped to support your business, no matter where your growth takes you. 

Entity Selection

Perhaps the foremost driver of international tax considerations is the entity structure the business chooses to establish its international operations. This selection frequently drives the extent to which the business is liable for tax in the foreign country, as well as, in the US. 

When it comes to selecting the most appropriate entity, leaders have several options:

• Branch: This is an extension of your existing US business and is not regarded as a separate legal entity. From a tax perspective, US businesses are subject to additional filing requirements and income tax on foreign activities, although losses generated by foreign activities may be available to offset US income.

• Controlled Foreign Corporation (CFC): A CFC is a corporation registered in an international country. To qualify as a CFC, a US entity must control a majority of the voting shares of the foreign corporation. Businesses are permitted to use a variety of classes of entity, such as the foreign country’s equivalent of a Limited Liability Company (LLC). 

• Joint Venture: Businesses set up a joint venture by partnering with a local business to set up a new entity in the foreign country. In an operational sense, this approach is often advantageous, streamlining the set-up process by leveraging local knowledge.

• Foreign Disregarded Entity (FDE): Provided they satisfy certain requirements, businesses can make a Form 8832 election, which results in the foreign entity being taxed normally in the foreign country, and treated similarly to a branch in the US.

The choice of entity structure is a crucial decision. Businesses should investigate the benefits and drawbacks of each entity type as they apply to their unique situation, particularly as it relates to repatriating profits to the US. It’s important to note that none of the entity structures listed here change how the business would generally be taxed in that foreign country as that is driven by how the country normally taxes that type of entity but rather the way the business entity or operations is taxed in the US. It’s best practice to seek guidance from an experienced tax firm to fully assess all options. 

Other Considerations and Tax Incentives

A business pursuing an international expansion has many decisions to make, including if and when it will bring the cash or profits earned back to the US. Adopting a well-thought-out approach is critical in ensuring the business can repatriate profits in the most tax-efficient manner possible, while still accomplishing operational goals.

Withholding Requirements. Various types of payments received from or paid to businesses outside the US have to address withholding requirements. The withholding rates can range up to 30% but many countries have tax treaties with the US and other foreign jurisdictions that provide lower rates and in many cases can be zero. Proper planning and structure can eliminate withholding requirements in many scenarios.

Global Intangible Low-Taxed Income. After the TCJA tax reform in 2018, several new international provisions were enacted. One of the primary provisions enacted is commonly referred to as GILTI, which stands for Global Intangible Low-Taxed Income. This provision ensures that businesses are liable for US income taxes on income from low-tax nations, even if they have not repatriated this income back to the US. This disincentivizes corporations from shifting profits on certain assets to nations with significantly lower tax rates than the US.

Transfer Pricing. Transfer pricing is an important consideration when determining the price that will be charged for goods and services exchanged between businesses under common control. Acceptable transfer pricing levels between parent and subsidiaries or brother/sister corporations in a multinational group of entities is imperative to avoid having regulatory authorities challenge the profit levels reported in their jurisdictions. Effective but legal transfer pricing takes advantage of different tax regimes in different countries to minimize the business’ overall global tax rate.

There is also a range of tax incentives available to businesses expanding their international footprint. Individual nations often have their own tax incentives to attract foreign investment, but there are also benefits in the US for domestic corporations expanding overseas. 

Here is a brief overview of several of the most common US tax incentives for businesses expanding internationally:

• Foreign Derived Intangible Income (FDII): The FDII deduction allows US C-Corporations to claim a 37.5% deduction on income derived from the sale of tangible and intangible products outside of the US.  

• Dividends Received Deduction (DRD): This deduction enables businesses who have received a dividend from another business (in this case, a foreign entity) to deduct this dividend from their income taxes. The level of deduction a business may claim is based on the ownership that the US taxpayer has in the dividend-paying business. 

• Foreign Tax Credits: If a business pays income tax in a foreign nation, they are eligible to claim a credit on their US income taxes to offset this––ensuring businesses avoid double taxation. 

• Interest Charge Domestic-International Sales Corporation (IC-DISC): If a business exports goods from the US, it may create a separate tax-exempt entity that makes an IC-DISC election. This allows the exporter to pay a commission to the IC-DISC and distribute those commissions as qualified dividends to the owners of the IC-DISC. These commissions are deductible from the exporting business’ federal taxes and the IC-DISC entity is treated as federally exempt, resulting in significant tax savings for exporters.  

Each of these tax incentives is complex and should be analyzed on a case-by-case basis by qualified accounting professionals with experience in international tax planning. 

Non-Tax Considerations When Your Business Expands Outside of the US

A tax-efficient approach is a vital component of a successful international expansion, but it’s far from the only consideration. There are a multitude of non-tax considerations that any business expanding overseas must bear in mind––especially when it comes to navigating the regulations of the country the business plans to expand into. 

Outside of the US, local regulations can vary dramatically. There may be language barriers, cultural differences, and other challenges that require business owners to take a fundamentally different approach to managing their business and employees. 

It’s important to have the support of trusted local professionals with the experience and connections to help your business navigate complex issues while remaining in compliance with all local regulations.

Smith + Howard – An Accounting Firm with Global Connections

The process of expanding your business outside of the US is an exciting time, but along with the new opportunities comes a variety of considerations: tax and otherwise. Through this journey, it’s vital you have the right support. Missteps in international tax reporting can be costly: in the US, failing to file even informational forms can result in penalties starting at $10,000 and going up significantly based on the forms and/or disclosures not filed. The penalties are generally assessed for each tax year in which the proper reporting was not completed.

At Smith + Howard, we’re proud to partner with domestic businesses embarking on exciting global expansion projects as well as foreign businesses looking to expand into the US. As members of an international alliance, we have access to a network of proven resources and professional talent in every corner of the world to assist us in navigating complex tax issues that your business may encounter throughout its lifecycle.

We provide end-to-end support: from evaluating which countries are the most attractive for expansion opportunities to international tax preparation. Through this journey, our focus is on helping our clients evaluate every possible scenario to deliver the best possible outcome for their business.

To learn more about how Smith + Howard can support you in evaluating tax and other considerations when expanding your business outside of the US, contact an advisor today.