Whether you’ve already jumped into overseas opportunities through buying, selling, or sourcing materials or have yet to develop a market strategy, one thing is for certain: There are plenty of hurdles, challenges, and tax consequences that come with doing business internationally.
For starters, it’s vital to ensure proper funding of your operations overseas—obviously from a cash flow standpoint, but also with the awareness that there are a number of countries with foreign direct investment (FDI) requirements. That means there will be a lot of registrations and restrictions related to money or capital coming into a foreign country, rules that are likely unfamiliar to your organization.
Another essential objective is to balance your tax requirements with your business requirements to find an optimal arrangement. Avoid overcomplicating, so you can grow comfortably into your structural, reporting, and legal requirements.
If you’re altogether new to the concept of exportation, the first step is to determine your legal structural entity and design it in the most tax-efficient manner possible. Basically, there are three structural considerations you will need to weigh:
- What country or countries in which to form your international presence.
- What type of entity your organization will be.
- Whether you will pursue check-the-box regulations, a U.S. tax concept.
Let’s explore these options.
Considerations for Selecting a Country
Just like holding a state-registered corporation yet doing business in several states, the same concept holds true internationally. You can form an entity in a country but not necessarily conduct all your operations or functions there.
As you’re thinking about your international expansion and choosing a country in which to structure, you should undertake a multidisciplined approach so as to determine where your product will be coming “from” and where it will be going. That includes operational considerations (determining where intellectual property will be held, where the workforce will be, where the product will be sourced, etc.), marketing considerations (where to sell product), legal considerations, and tax considerations (understanding the various import duties and customs).
As you’re thinking about the country in which to establish your foreign operations, consider the country’s financial and economic infrastructure as well as its political and legal stability. We take these factors for granted in the United States, but they can have a significant impact on your international efforts. If you’re forced to spend a lot of time litigating or investing far too many resources getting goods out of customs, these factors can negatively impact your cash flow.
Employment laws are another critical factor to understand. They can be quite complicated and vary dramatically from country to country. For instance, a number of foreign jurisdictions are unfamiliar with the concept of employment at will. Instead, employers can be contractually obligated to hire employees for an established period of time or indefinitely unless there’s serious cause for dismissal. There are also an assortment of notice provisions should you decide to sell or merge your company. In addition, severance is mandatory in some countries, and there are numerous general laws concerning employee contracts and handbooks.
Accounting requirements are another key consideration. Many countries have statutory auditing requirements. Even privately held companies may be required to submit their financial statements to a foreign government, which in some cases will publish that information in a subscription database.
Understanding a country’s tax system is a big concern and can determine your company’s viability to export. Does the country’s tax system ensure or impede efficient cash flow? Does it support tax-effective financing? Can taxes and customs costs be reduced as a result of the tax treaty network? Are there low withholding taxes?
Keep in mind that even if your organization has no physical presence in a foreign country but is leasing software or equipment, for example, you could still be subject to tax. The foreign consumer would actually withhold tax on the remittance back to you, net of a statutory withholding amount.
Equally vital is the need to recognize taxes on FDI. Numerous countries have restrictions on currency coming in or out because of its impact on their domestic currency. Numerous countries also have compliance requirements regarding the types of tax returns or information filing that must be performed.
Human resources, language, culture, and work visas are all additional considerations for international expansion, as are the availability of goods and materials needed and the availability of financial assistance (e.g., grants or land).
Considerations for Selecting an Entity
Say you wish to establish a separate entity abroad. Be aware that countries have various legal organizational requirements. Some countries require that there be a local owner or local representatives serving on your board of directors. Or there may be officer requirements such as the nationality, numbers, or locations of those officers.
In many cases there are also capitalization requirements. Several countries have set, registered minimum equity requirements. They’ll determine those requirements by looking at your industry sector and your location, then establishing the minimum capital contribution you have to make if you want to proceed. Some countries also have debt-to-equity ratio limitations.
Before you start moving money back and forth, it’s essential to understand how your entity will maintain its solvency over time, particularly in countries with strict FDI requirements.
So what kind of entity should you choose? In the United States you can choose to be an LLC, a partnership, an S corporation, or a C corporation, for instance. Many foreign jurisdictions also offer a number of different structural entities from which to choose.
When you decide to market overseas or plan for foreign operations, you will want to identify your business needs and decide which entity structure is most appropriate. Your primary choices include:
- Establishing an agency relationship.
- Setting up a representative office.
- Creating a branch or forming a subsidiary.
- Securing a joint venture with a foreign entity.
Each has its pros and cons.
Agency relationships. Using independent agents may be the simplest way to establish a market in a foreign jurisdiction without creating a tax footprint or legal entity. Examples can include using third-party distributors or service providers to help bring your products or services to those new foreign customers.
You’ll need to carefully think through the contractual relationship, however, in order to authentically support the concept of “independent” as defined by the foreign jurisdiction. Consider the rights and obligations of the independent agent, and draft legal agreements to protect both parties.
Representative office. Registering a representative office in a country can be a good way to put your feet on the ground without creating a corporate income tax presence. Lots of countries have representative offices. While they are not technically considered a fully separate and legal entity, many countries do consider them to be desirable separate entities from those in the United States.
Keep in mind, however, that the functions of representative offices are limited, usually to auxiliary and preparatory activities that do not directly lead to revenue generation. Such activities typically include market research and information gathering, product or service promotion (without sales negotiations or entering into contracts), and other non-transactional operations. In other words, think of a representative office as a cost center that’s set up to perform a lot of on-the-ground functions—marketing and promotions—without the revenue-generating activity.
Branch operations. Branches are U.S. companies that are not setting up separate legal entities in the foreign jurisdiction but instead are operating overseas under the same corporate veil or umbrella of their U.S. jurisdiction. There are some additional tax considerations for this option.
From a U.S. perspective, income derived by the foreign branch presents foreign source income, which is earned by the U.S. parent. U.S. persons generally are subject to tax on worldwide income at regular tax rates.
The repatriation of branch profits back to the United States may not be a taxable event in a foreign country. However, in some countries (such as the United States) a branch profits tax is levied on the “dividend equivalent amount.”
Subsidiary operations. A subsidiary is a legal entity totally separate from its U.S. parent. This helps to separate the legal exposure from U.S. and foreign jurisdictions.
In general, the profits of a subsidiary are subject to tax in the foreign country. Such profits are not subject to tax in the United States until such time as they are repatriated. There are a few exceptions to this, but in general this statement holds true.
Joint venture operations. A joint venture may be used to enter a market in a manner that mitigates entrepreneurial risk. The joint venture may be just a business agreement, or it may take the form of a partnership or jointly held subsidiary. Be aware that some foreign jurisdictions consider a joint venture to be a separate legal entity.
Companies typically pursue joint ventures to gain faster entry into a new market; acquire expertise; increase production scale, efficiencies, or coverage; or expand business development by gaining access to distributor networks.
How a foreign jurisdiction will tax you depends on the legal structure you decide on. In contrast, the U.S. tax concept of “check the box” offers two different tax treatments to consider, no matter the structure you choose.
Sec. 7701 and the regulations under 301.7701-3 allow individual and corporate owners of foreign entities (meeting certain requirements) to elect whether to treat the entity as either a taxable corporation, which is an entity disregarded from its owner, or a partnership, if there is more than one shareholder. So no matter how you’re being taxed by a foreign country, you can also elect how you wish to be taxed by the United States.
To be sure, there are many challenges to exportation, as described above. Yet there are also incredible growth opportunities waiting. Understanding your best option for structuring your entity is the first step to success.