By Tim Moore, EO Houston member and managing partner, TR Moore & Company, a Doeren Mayhew Firm
Not long ago, international business was the domain of large corporations. Today, the Internet, advances in freight and logistics, and other developments have made global markets accessible to even the smallest businesses.
But just because some barriers have been lowered doesn’t mean doing business internationally is easy. In fact, it’s a complex process that requires a company to establish the necessary infrastructure, develop an understanding of foreign cultures, and prepare for a new tax environment. Careful tax planning can help you set up your international business in a manner that minimizes worldwide taxes and maximizes cash flow. Considerations include:
There are many ways to do business abroad.The right strategy depends on several factors, including the laws of the country in which you wish to do business and the level of control you seek.
The structure of your global operations also has significant tax implications. Suppose, for example, that your business operates as an S corporation. Without careful planning, you may find yourself subject to double taxation on foreign income, paying corporate-level taxes in the foreign country and individual-level taxes in the United States.
You can minimize or eliminate double taxation by setting up a hybrid structure — that is, one that’s treated as a taxable entity in one country and a pass-through entity in another — and filing the appropriate elections. These structures allow foreign corporate-level taxes to flow through to the individual owners as credits against U.S. income tax. There may still be double taxation, however, to the extent that the foreign tax rates are higher than an owner’s U.S. income tax rate.
Corporate structure also affects a company’s ability to take advantage of foreign losses or to defer U.S. taxes on foreign income. For example, if a foreign operation is structured as a hybrid entity or as a branch or division, the owners may enjoy significant tax benefits by deducting foreign losses (subject to passive activity loss rules and other restrictions).
On the other hand, if you’re doing business in a country with low taxes, operating through a foreign subsidiary may allow you to defer U.S. taxes on foreign income (subject to limitations). For some companies, an interest charge-domestic international sales corporation (IC-DISC) can provide similar benefits at a low cost.
Income Tax Withholding & Credits
It’s critical to understand a foreign country’s income tax laws, regulations and procedures, and particularly important to consider withholding taxes. If your company doesn’t have a physical presence in a country, that country may impose significant withholding taxes on gross income.
The availability of foreign tax credits is crucial to avoiding taxation of income by both the foreign country and the United States. Withholding taxes paid to another country generally entitle your company to a dollar-for-dollar direct credit against U.S. tax liability.
But if you operate through a foreign subsidiary, it’s a bit more complicated. The subsidiary pays corporate-level taxes on foreign income, which becomes taxable in the United States when it’s distributed to the parent. The parent can claim an indirect tax credit for foreign taxes paid, subject to certain ownership requirements and limitations on the amount of the credit for certain types of income.
Don’t overlook indirect taxes, such as customs duties and value-added tax (VAT). Duties vary substantially from country to country and even from product to product. And there may be opportunities to minimize duties by categorizing products in a certain way or by unbundling products and reassembling the components after they’re imported.
A VAT is similar to sales tax, except it’s imposed on the amount of value added at each level of the production process. Generally, the seller is responsible for collecting and remitting the tax, offset by any VAT the seller has paid to others.
If goods will be stored in inventory for an extended period of time, consider using a bonded warehouse to defer customs duties and VAT.