Whether you are buying an existing business that has overseas operations or you are setting up a new venture in another country, there are a lot of things to account for. A company may consider expanding overseas for numerous reasons: to be closer to suppliers, to serve new markets, or to take advantage of lower production costs. In some cases, it may even be to circumvent trade restrictions or tax burdens in the home country.
Businesses that are considering overseas expansion need to take tax considerations into account from the outset. Different countries have different tax regimes, and there are a number of international treaties and conventions that need to be considered.
“Taking a global approach is critical to some products' success.”
Why Might a Business Move Overseas?
There are several reasons why a business might choose to move part or all of its operations overseas. Let's examine some of the most common reasons:
Access New Markets
A company may expand overseas to gain access to new markets. By selling its products or services in new markets, a company can potentially increase its sales and profits. In addition, expanding into new markets can help a company to diversify its business and reduce its reliance on any one particular market.
Taking a global approach is critical to some products' success. For example, Uber can be equally useful in New York City as it is in London. To capture its entire potential market, Uber now operates in over 10,000 cities across the world in Europe, Asia, North and South America, Australia, and Africa.
Political factors occasionally play a role in a company's decision to expand overseas. A company may choose to expand into a politically stable country, has friendly relations with the home country, and offers a favorable business environment.
Conversely, a company may choose to expand into a country that presents more political risk to take advantage of opportunities that exist there. For example, despite the political instability in the Middle East, many businesses continue to operate in the region because of the lucrative business opportunities that exist there.
Some countries also offer favorable tax policies for businesses. For example, an American business owner who sets up an offshore company in the Cayman Islands can take advantage of the country's 0% corporate tax rate. Google, Pfizer, Oracle, Facebook, and Microsoft have all used strategies like this to save hundreds of millions of dollars in taxes.
Government Incentives and Special Economic Zones
In some cases, a government may offer incentives to businesses that expand into their country. These incentives can take the form of subsidies, tax breaks, or other financial assistance.
Some countries also establish special economic zones (SEZs) to attract foreign investment. SEZs are regions that have reduced or eliminated taxes, simplified regulations, and infrastructure designed to attract foreign businesses. China has established over a dozen SEZs, including the Shenzhen Special Economic Zone and the Shanghai Free-Trade Zone.
Lower Labor Costs
In many countries across the world, such as China, India, and Bangladesh, labor costs are significantly lower than they are in developed countries like the United States. As a result, companies that expand into these countries can potentially save a significant amount of money on labor costs.
In addition to saving on labor costs, companies may also be able to take advantage of lower production costs in these countries. For example, the cost of manufacturing a product in China is often much lower than the cost of manufacturing the same product in the United States.
“As a corporation, income is subject to U.S. corporate tax, while loss can be used to offset other income on the company's tax return. However, as a branch, income and losses are subject to immediate U.S. taxation.”
Considerations When Moving Your Business Overseas
Starting a business is already difficult. If you're looking into global expansion, it's even harder. When moving a business venture overseas, there are many things to consider. Here are some important factors to keep in mind:
Your Business Structure
The United States has one of the world's highest corporate tax rates, so it's no surprise that many businesses choose to set up an offshore company in a country with lower taxes.
However, becoming a multinational business means more than just setting up an offshore company. You may be subjected to additional layers of taxation, so it's important to consult with a tax advisor from a firm like Pherrus Financial to ensure that you're structured in the most tax-efficient way possible. A few examples of tax implications you could run into regarding your business structure include:
- Foreign income tax: You may be required to pay income tax in the country where your company is based, as well as in the United States.
- Branch profits tax: If you have a branch office in another country, you may be subject to a branch profits tax on the earnings from that location. This is in addition to any income taxes you may owe in the country where the branch is located.
- Double taxation: If your company is based in a country with which the United States has a double taxation agreement, you may be able to avoid paying taxes on the same income twice.
- Withholding taxes: If you have employees in another country, you may be required to withhold taxes from their paychecks and remit those taxes to the appropriate authorities.
- US income tax on internationally-sourced income: You may be required to pay US income tax on income that your company earns in other countries.
There are many other potential tax implications of expanding your business internationally. When deciding whether to operate as a corporation or a branch of the U.S. parent, there are a number of factors to consider. One is the tax treatment of income and losses.
As a corporation, income is subject to U.S. corporate tax, while loss can be used to offset other income on the company's tax return. However, as a branch, income and losses are subject to immediate U.S. taxation.
Another factor is the level of control that the U.S. parent wishes to maintain over the subsidiary. If the subsidiary is operated as a corporation, it will have more autonomy than if it is operated as a branch.
It is also crucial to consider the costs and complexities associated with each structure. Operating as a corporation requires compliance with corporate governance rules and filing annual reports. Operating as a branch generally requires less paperwork and compliance with fewer regulations.
Taxable Presence in the Foreign Country
Creating a permanent establishment (PE) in a foreign country can trigger corporate income tax obligations. A PE is typically created when a company has employees or assets in a foreign country, but it can also be created by having an agent or office in the foreign country.
In order for a PE to exist, there must be a sufficient level of activity in the foreign country. The level of activity required varies from country to country, but it is typically based on factors such as the number of employees in the foreign country, the amount of equipment or other assets in the foreign country, and the amount of sales made in the foreign country.
Creating a PE in another nation can pose an issue because then your company is subject to taxes there. Even if you haven't established a permanent establishment, other actions might be seen as such, leaving you susceptible to the regulations of that government's officials. Even having a few employees in an international location could be seen as a taxable presence.
While the IRS does not provide a definition for "permanent establishment" in a foreign country, there may be tax treaties between the United States and the local nation. Depending on where the business is established, and what type of business it is, there might be an uneven allocation of income. The uneven allocation will probably be skewed in favor of the foreign country.
When expanding into international business, it is important to be aware of the regulations surrounding cash repatriation. Cash repatriation is the process of transferring money from one country to another. In most cases, businesses will need to obtain a special license in order to repatriate funds. This license is typically obtained from the Central Bank of the country where the funds are being transferred.
Businesses should also be aware of any taxes or fees that may be associated with cash repatriation. Failure to comply with the regulations surrounding cash repatriation can result in significant penalties. As a result, it is essential for businesses to consult with a professional before expanding into international markets. Here are a few tips when considering cash repatriation:
- Consider using dividends, royalty payments, or other methods to repatriate funds instead of direct transfers.
- Obtain a foreign tax credit for any taxes paid on repatriated income.
- Be aware of any restrictions or limitations that may be placed on the repatriation of funds.
Intangible Property Migration
Another issue to be aware of when expanding into international business is the migration of intangible property. Intangible property is any type of nonphysical asset, such as a patent, copyright, or trademark. When intangible property is transferred from one country to another, it is considered a migration. Migration can trigger a number of tax consequences, including the imposition of taxes in the country where the property is transferred.
The globalization of commerce has led to a situation in which the geographic location of intangibles can have a significant impact on corporate profit and tax liability. This is because tax rates vary widely from one jurisdiction to another, and the location of intangibles can be a deciding factor in where profits are generated and taxes are paid. Consequently, the value of intangibles can have a significant impact on the effective tax rate of a multinational business and its enterprise value.
The current US tax system uses a “worldwide” tax system, which subjects multinational companies with US parent companies to a minimum tax on profit above a set rate of return that’s accrued by their foreign affiliates. In contrast, most other countries apply a territorial tax system that exempts resident multinationals’ active-foreign-source income from taxation.
In 2017, the US switched to a territorial tax system, which has created an opportunity for US companies to “invert” their tax domiciles. An inversion is a corporate restructuring in which the new parent company of a multinational group is located in a foreign country with a lower corporate tax rate than the United States.
Employees vs. Contractors In International Business
When expanding your business internationally, you will need to decide whether to hire employees or contractors. There are pros and cons to both options. Employees offer certain advantages, such as the ability to train them in company procedures and the development of long-term relationships. However, they also come with disadvantages, such as the potential for higher costs and the need to comply with employment laws in multiple jurisdictions.
Contractors offer the advantage of flexibility, as well as the ability to hire them for specific projects. However, they also come with disadvantages, such as the need to manage multiple relationships and the potential for legal disputes. When hiring in-house employees overseas, there are also a few things to keep in mind:
- You will need to comply with employment laws in the jurisdiction where they are employed.
- You will need to withhold taxes from their paychecks depending on the jurisdiction.
- The labor laws in the jurisdiction may require you to provide certain benefits, such as health insurance.
A withholding tax is a tax that is withheld by the payer of an income on behalf of the recipient. The withholding tax rate depends on the jurisdiction in which the income is earned, as well as the type of income. For example, in the United States, wages are subject to a federal withholding tax, as well as state and local taxes in some jurisdictions. Interest and dividends are also subject to withholding tax.
In most cases, the withholding tax is credited against the recipient’s taxes payable for the year. However, in some cases, the withholding tax may be refundable if the recipient does not owe any taxes for the year.
When expanding your business internationally, it is important to be aware of the withholding tax rates in the jurisdictions in which you are operating. This is because the withholding tax can have a significant impact on your company’s cash flow.
“If you own a patent on a new product, you could transfer the ownership of the patent to a holding company in a country with a lower corporate tax rate. This would allow you to reduce your taxes on the patent income.”
Top International Tax Planning Strategies
Now that we have discussed some of the basics of international taxation, let’s take a look at some strategies that you can use to minimize your tax liability.
One common way to minimize your tax liability is to shift income from high-tax jurisdictions to low-tax jurisdictions. This can be done by transferring ownership of assets or intellectual property to a lower-tax jurisdiction. For example, if you own a patent on a new product, you could transfer the ownership of the patent to a holding company in a country with a lower corporate tax rate. This would allow you to reduce your taxes on the patent income.
Regulatory arbitrage is the tax planning process of taking advantage of discrepancies between two or more regulatory regimes in order to gain a competitive advantage. This can be done by exploiting loopholes, seeking out regulatory havens, or simply by structuring transactions in a way that takes advantage of different rules.
If two countries handle overseas branches differently, there is room for regulatory arbitrage. One country may allow overseas branches to be 100% foreign-owned, while the other may require a certain percentage of ownership by domestic residents. This provides an opportunity for businesses to minimize their taxes by locating their operations in the country that offers the most favorable treatment.
Double Tax Treaties
A double tax treaty is an agreement between two countries that allows taxpayers to avoid paying taxes on the same income in both jurisdictions. These treaties typically provide for lower withholding tax rates on cross-border payments, as well as exemptions or reductions in other taxes.
Double tax treaties can be a valuable tool for reducing your international tax liability. However, it is important to note that these treaties only apply to taxes imposed by the government, not to private taxes, such as sales tax or value-added tax. If you are expanding your business internationally, it is important to be aware of the various tax considerations that may apply to your business specifically.
A tax haven is a jurisdiction with low or no taxes that is used by taxpayers to avoid paying taxes in their home country. Tax havens are often used by wealthy individuals and multinational corporations to minimize their tax liability.
While there are some legitimate uses for tax havens, they can also be used for illegal purposes, such as money laundering or evading taxes. For this reason, tax havens have come under increased scrutiny in recent years. If you are considering using a tax haven to reduce your international tax liability, it is important to consult with a tax advisor to ensure that you are doing so legally.
This is just a quick guide to some of the tax considerations that you need to be aware of when expanding your business internationally. For more detailed information, it is best to consult with a qualified tax advisor.
By following the tips in this guide, you can minimize your international tax liability and ensure that your business is compliant with the laws in the jurisdictions in which you are operating. This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified lawyer or accountant for specific advice on your situation.