When a domestic company begins operations in another country, its tax picture grows dramatically more complicated. If an international expansion is part of your company’s growth strategy, your financial management and tax teams will need to make a number of critical tax-related decisions in addition to the many strategic, competitive, and financial considerations your company already must address.
Here are seven important tax-related variables that will affect when, where, how, and even whether you launch overseas operations. While these are by no means the only issues you must consider, your answers to these questions will drive much of your future decision-making.
- What is the reason for the expansion? Are you looking for a new market for your products or services? Are you expanding your R&D or production capabilities? Or do you have some other purpose in mind? The answer to this most fundamental question will shape your expansion strategy.
- How will your foreign operations be organized? Will you open a branch office of your U.S. business, or will you establish a foreign subsidiary that is owned by a U.S. parent or holding company? The choice depends on many strategic and operational factors, but the decision will have far-reaching tax consequences.
- How are both entities structured? If you establish a separate foreign subsidiary, the tax treatment of its earnings will depend on whether your U.S. company is a traditional C corporation or a pass-through entity. In addition, you must decide if the foreign entity is to operate as a controlled foreign corporation (CFC) or as a disregarded entity (DRE). This decision will affect how and where the company’s income, expenses, and profits are recorded and taxed. The tax laws of the other country are likely to offer similar choices for structuring the foreign entity.
- Is there a tax treaty between the United States and the other country? To avoid double taxation, the U.S. has reciprocal agreements with many countries covering a range of taxes including income taxes, inheritance taxes, value added taxes, and other forms of wealth or earnings taxes. U.S. taxpayers who pay taxes to a treaty country may be entitled to certain credits, deductions, exemptions, or rate reductions.
- How will you fund the overseas entity? If you establish a subsidiary company, will the initial funding be recorded as capital or debt? The answer will affect whether the subsidiary’s payments to the parent are considered tax-deductible interest payments or taxable dividends. In addition, many countries require that foreign-owned businesses operating in their jurisdiction maintain certain minimum debt-to-equity ratios.
- What are the rules regarding transfer pricing? Because corporate tax rates can vary significantly, businesses often structure their operations so that profits are taxed in the country with the lower rate. Transfer pricing regulations prohibit companies from unfairly manipulating transactions in ways that would cause either country to receive less than what it regards as its rightful share of the tax revenue. This can be the most complex of all the questions to be decided—and also one of the most consequential—so you will certainly need guidance from your tax professional.
- How will the tax laws be changing? From proposals to raise U.S. corporate tax rates, to changes in global intangible low-taxed income (GILTI) regulations, to the suggested global minimum tax for large multinational corporations, the rules and the rates are continually evolving. Staying abreast of the most recent changes and anticipating how future revisions could affect you are essential to a successful international expansion.
Non-tax issues—such as the availability of qualified workers and managers, compatibility of the two cultures, and the host country’s business and legal environment—are often the determining factors in an overseas expansion. Nevertheless, a successful international growth strategy is not possible without a thorough analysis of the tax questions that will arise.