Tax-Efficient Expansion Outside the United States

By Brian Mitchell
Whitley Penn, LLP
Fort Worth Chapter, Texas Society of CPAs

When considering the expansion of your operations outside the United States, a number of tax, business, legal, and regulatory issues should be addressed in advance to ensure the overall objectives of the expansion are satisfied. The key considerations include:

The company’s commercial footprint in the new territory

Determine the activities, assets, and personnel that the company will deploy outside the U.S. The range of activities may vary from a limited scope and duration to a full-scale operation with long-term deployment of capital, plant and equipment, and local workforce. The scope of the operation will determine the impact of foreign income tax, sales or value-added tax, and transfer tax.

The company’s sales strategy in the new market 

Sending sales and other professionals into a new jurisdiction can cause the company to be taxable in that jurisdiction. These foreign tax costs, as well as the costs of outside advisors and business start-up, can be expensive and should be evaluated as part of the overall sales opportunity and product pricing.

The company’s decision to operate as a local foreign entity or as a branch

This decision should be based on the applicable business, tax, legal, and regulatory issues. Your tax advisor and attorney should work together to determine the best operational structure. A foreign legal entity generally costs more to administer than a branch, so initially, the company should consider operating as a branch.

The company’s capitalization of a separate local foreign entity

Decisions on funding operations with a combination of equity and intercompany loans should be made at the formation of the entity. Intercompany loans to a foreign entity provide a valuable tax shield in the form of interest deductions at the local level. However, the foreign jurisdiction can reclassify debt as equity if a loan is not respected as a bona fide debt. Reclassification of equity as debt will impact the treatment of funds transferred from the foreign entity, including the deductibility of interest expense and the applicability of income tax withholding requirements.

The company’s U.S. taxation and reporting of foreign operations

Based on current law, U.S. persons are taxed on a worldwide basis. Therefore, the company should consider the U.S. tax effects of foreign expansion. If foreign source earnings are earned through a foreign entity, those earnings may be deferred from U.S. taxation until repatriated as a dividend. However, special rules that require the immediate U.S. taxation of income earned by a foreign subsidiary may apply.

The U.S. also imposes certain reporting requirements for foreign operations. Failure to meet these filing requirements can result in substantial penalties. Typical filing requirements include:

Form 5471
Information Return of U.S. Persons With Respect to Certain Foreign Corporations. An annually required information report of a non-U.S. company that is controlled by a U.S. person.

Form 8621
Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. An annually required information report of a non-U.S. company that is not controlled by a U.S. person and that generates certain types of income or holds certain types of assets. 

Form 8865 
Return of U.S. Persons With Respect to Certain Foreign Partnerships. An annually required information report of ownership of entities treated as non-U.S. partnerships.

Other forms:
Form 8858, Form 926, Form 1118/1116, Form 5472, Form 8804/8804/1042.

Summary

When considering expansion into foreign jurisdictions, U.S. companies should consult both their U.S. and foreign advisors to ensure that all potential tax issues related to that expansion are addressed as part of the overall business considerations related to that expansion.

Brian Mitchell, CPA, is director of international tax at Whitley Penn LLP, one of the region’s most distinguished public accounting firms. He is writing this column on behalf of the Fort Worth Chapter of the Texas Society of Certified Public Accountants, a regular contributor to FW Inc.