Whether foreign investors are engaged in a trade or business in the U.S. is generally a question of fact, meaning that there are no hard rules that result in a plain vanilla “yes” or “no” answer. Sometimes foreign investors are conducting a U.S. business without even knowing it; a topic that can be explored in great lengths all on its own. For investors intentionally conducting business in the United States, this article is for you.
A U.S. trade or business is subject to U.S. income taxes and obligated to file an annual tax return. How you structure your operations in the U.S. will determine how you will be taxed. Here are three tax-motivated reasons to consider conducting your U.S. business in the form of a corporation.
Are you a foreign corporation? If so, you may be aware that the U.S. tax law imposes a double-taxation regime on the income earned by corporations. The first level of tax is levied upon the income of the corporation, with the second-level of tax levied upon the shareholders receiving distributions from the corporation’s earnings and profits. Foreign corporations conducting an unincorporated business in the U.S. are generally considered to be doing so through a separate U.S. branch.
The U.S. tax law imposes a branch profits tax designed to parallel the double-taxation regime for corporations, effectively equalizing the tax treatment of a U.S. branch compared to a U.S. corporation. Not only is tax imposed on the earnings of the U.S. branch, but an additional withholding tax is imposed on undistributed earnings, simulating the tax that would be imposed on shareholders receiving dividends from a U.S. corporation. Under the branch profits tax, the earnings of the business are deemed to be distributed to the foreign owner in the year that they are earned. By incorporating the U.S. business, the foreign corporation would not be subject to the second-level of taxation until it receives a distribution of profits. Simply put, the timing of the tax liability follows the timing of the cash repatriated.
Conducting a U.S. business through a form of business other than a corporation (i.e., partnerships or LLCs) can result in the unwelcome filing of additional tax returns. Not only will the U.S. business have to file its own tax return, but the foreign owners will generally be required to separately file tax returns and pay their share of tax on the U.S. income. A foreign owner should not want to or have to do that. It should try and stay clear from the U.S. tax authorities as often as possible, and forming a U.S. corporation will achieve this. This motive is commonly referred to as setting up a U.S. “blocker” corporation, since the corporation effectively “blocks” the foreign owner from the obligation to file a U.S. tax return. “Blocker” corporations are commonly seen in private equity structures where foreign persons are indirectly invested in U.S. businesses.
A third benefit of incorporating your U.S. trade or business is minimizing complexities in maintaining the proper tax accounting records. A foreign owner of a business operating in the United States may not want to go through the trouble of setting up and maintaining books and records for a new separate entity. However, maintaining separate books and records for a separate U.S. corporation yields several benefits.
Doing so will help foreign owners track personnel expenses in order to comply with U.S. payroll tax obligations, allow management to better analyze the performance of the U.S. business, and provide the opportunity to manage exchange rates with respect to intercompany transactions and cash repatriation. Most importantly, separate books and records allow the business to account for two important U.S. tax concepts: effectively connected earnings and profits (“E&P”) and U.S. net equity. E&P and U.S. net equity are both required to be reported on the company’s annual U.S. tax return and are critical in determining the branch profits tax. Failure to properly maintain these two items could result in the company underpaying, or perhaps worse, unnecessarily overpaying its U.S. income taxes.
Aside from these issues, there are multiple tax planning opportunities that may be available to your business. It is always recommended that businesses and investors consult their tax advisor and perform the proper planning before deciding to conduct business in a new country.
If you have any questions, please reach out to a member of Withum’s International Services Team at firstname.lastname@example.org.
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.