United States (US) Taxable Person – Planning your Foreign Business Investment and Operations:
US Person (Individual or Company) doing business outside the US –
Branch Vs Subsidiary
Suppose you are a US person starting a business outside the US. In that case, it is crucial that you plan this venture carefully in order to take advantage of all tax benefits available to you that would significantly reduce your tax bill and take advantage of the available credits and deductions whilst ensuring you are in compliance with the reporting requirements as per the IRS and tax codes which can be enormous.
There are several options available to a US person who wishes to conduct business abroad. Deciding on the option will directly impact your taxable income and available credits and exemptions in accordance with the US tax codes. This would also need to be planned in line with the foreign country taxation.
Structuring the Foreign Business and Operation:
A US person who engages in sales, service, or manufacturing activities abroad can structure that foreign operation as either a branch or a subsidiary. Therefore, a central tax issue in planning for foreign operations is determining the best legal structure, taking into consideration the business and legal requirements as well as the tax advantages and savings available for every available option. This process often is complicated and should be analysed and studied very carefully.
Foreign investment tax planning involves the interplay of the tax laws of two or more countries. From a US person’s perspective, the goal of foreign overseas investment tax planning is to reduce the US and foreign taxes on foreign-source income. Foreign income taxes increase a US person’s total tax costs only to the extent that they are not creditable for US tax purposes. A US person can reduce these excess credits through either foreign tax reduction planning or planning that increases the credit limitation. With respect to US taxes, the United States generally collects any residual US taxes on low-tax foreign-source income. Nevertheless, foreign-source income can give rise to opportunities to defer or permanently reduce US taxes (e.g., the dividends received deduction). Other foreign overseas investment planning focuses on taking advantage of the dividends received deduction and avoiding the anti-deferral regimes.
The choice between a branch and a subsidiary must take into account not only US and foreign tax laws but also general business considerations.
Tax advantages of the subsidiary form include the following:
- A subsidiary generally allows a U S. company to avoid the residual U S tax on low-tax foreign-source income via the dividends received deduction.
- A subsidiary provides more control over the timing of income recognition for US tax purposes (and possible exemption), which may be useful in planning.
- Local tax incentives in the foreign country, such as a tax holiday, may be available only to a locally incorporated subsidiary.
- The sale of shares of a subsidiary results in a capital gain that the foreign country may not tax.
- The separate legal status of a subsidiary may make it easier to justify management fees and other intercompany charges (such as an allocation of indirect expenses) to foreign tax authorities.
Tax advantages of the branch form include the following:
- A U S. company can deduct the foreign losses of a branch against its US profits. However, the US company would recapture these losses as income by subsequently incorporating the branch.
- The transfer of assets to a branch is a nontaxable event. In contrast, the transfer of appreciated property to a foreign subsidiary can trigger gain recognition.
- S corporation shareholders, generally individuals, must pay tax on dividends received from a foreign subsidiary. However, these individuals can claim a direct credit for the foreign taxes paid directly on the income of a branch. This aspect of a branch form is also advantageous for individuals who are either partners in a US partnership or members of a US limited liability company that is a partnership for US tax purposes.
- There may not be any foreign taxes when a branch repatriates its profits, whereas dividends paid by a subsidiary generally attract foreign withholding taxes.
General business factors that a US person should consider when choosing between the branch and subsidiary form include:
- A subsidiary insulates the US company from legal liability issues in the foreign country.
- A subsidiary may present a better local image to potential customers and employees.
- A U S. company may find it simpler to operate a branch. For example, foreign business registration and financial reporting requirements of a branch may be less onerous than those for an incorporated subsidiary.
- Foreign laws may require a subsidiary to have outside local shareholders or directors.
- A subsidiary may make it easier to involve local investors in the venture because a subsidiary can issue additional shares to those local investors.
- The use of a branch avoids the minimum capitalisation requirements that some foreign countries impose on subsidiaries.
There is no single best option that fits all, i.e., a sole establishment might be an option. However, it might be considered a pass-through entity and, in effect, similar to a branch for US tax purposes but differently for local tax and legal purposes. Every case must be analysed and assessed separately and independently.
If you are a US person, whether as a US individual (Citizen or resident) or a business/company considering a new investment and business overseas, we are here to help you make the best tax and legal position for your venture.