Our world has grown smaller, making exporting or expanding a genuine opportunity for companies of any and all sizes. But there are many tax repercussions to address, and simply being aware that taxes will be “different” is not the same as actively planning for them. After all, every business is different, and every foreign jurisdiction is also different.
International tax planning helps support your organization’s business objectives. The process will keep profits within your organization rather than paying them away in taxes. That means an increase in cash flow to be used to grow your business and lay the foundation for future operations.
Good planning can also result in a comprehensive strategy to be used in evaluating and capitalizing on international opportunities as they arise.
The goals of international planning are clear, yet some are not as obvious as others. Your objectives should include:
- Achieving a low tax rate to provide more after-tax dollars to reinvest.
- Avoiding startup or other unbenefited losses that can be trapped in foreign countries.
- Providing flexibility to redeploy cash within the structure where needed.
- Achieving low or no withholding taxes on passive income payments such as dividends, interest, and royalties.
- Promoting maximum foreign tax credit utilization to avoid double taxation for foreign earned profits.
- Avoiding unexpected anti-deferral income inclusions that could be foreign tax credit and cash management issues.
The elements of international income taxation to U.S. companies always includes a conversation about Subpart F.
Basics of Anti-Deferral Income Inclusions (Subpart F)
Based on the general rule of deferral, U.S. tax on the income of a foreign corporation is deferred until the income is actually repatriated to the U.S. shareholders. But there are exceptions, as outlined by Subpart F of the Internal Revenue Code.
Interest may be charged on excess passive income (dividends, interest, rents, royalties, etc.) compared to active trading income.
Anti-deferral income also includes conduit sales income and conduit services income.
Conduit sales income
Conduit services income
- You buy from a related party (usually outside the buy-sell distributor’s country), then sell to anyone outside the buy/sell distributor’s country.
- You buy from an unrelated party (usually outside the buy/sell distributor’s country), then sell to a related party outside the buy/sell distributor’s country.
- You sell property to any person on behalf of a related party.
- You purchase property from any person on behalf of a related party.
- You perform services for or on behalf of a related person, when such services are rendered outside the service provider’s country of incorporation.
- You perform services with substantial assistance from a related person, when such services are performed outside the service provider’s and related party’s country of incorporation.
Basic International Tax Strategy
In planning, your company must make a key decision about what will happen to the cash generated from foreign operations. There are two options, and each has benefits and costs.
The first is a repatriation strategy in which the company needs and wants the cash in the United States to pay shareholders, service debt, and/or expand U.S. operations. The benefits are that transactions can be structured to support cash movements to U.S. parent/group companies while avoiding double taxation on movements of cash and striving to pay tax currently at applicable U.S. tax rates. Profits and taxes also are minimized in foreign jurisdictions.
The costs of a repatriation strategy, however, include losing the ability to defer U.S. taxes and take advantage of potentially lower foreign tax rates and facing a higher effective tax rate.
The second choice is a reinvestment strategy, wherein the company needs cash outside the United States to grow and expand international operations. The benefits are profits that are maximized by zero or low tax rates in foreign jurisdictions and the ability to grow international operations using more after-tax cash. Overall, you realize a lower worldwide effective tax rate.
The costs, on the other hand, are that cash must remain outside the United States to achieve the benefits, and there could possibly be higher tax costs upon ultimate repatriation.
Foreign Tax Credit Considerations
No matter your chosen cash strategy, there are two types of foreign tax credits available that can help alleviate heavy double taxation.
The first is a direct foreign tax credit (IRC 901). With it, foreign taxes are imposed directly on the U.S. taxpayer, there are withholding taxes on remittances, and taxes are paid on foreign earnings of branch operations.
The indirect foreign tax credit (IRC 902) offers deemed paid or indirect credit for foreign taxes based on the proportion of taxes paid by a corporation on its distributed earnings and profits. It should be noted that there are restrictions on who is eligible to claim the indirect foreign tax credit.
Go Global…But Plan Your Strategy
Taxes on your foreign income need not impede your global competitiveness. The landscape is complicated, but it can be conquered. Recognize the regulations and systems, develop a strategy, and prepare for success.