As the world gets flatter and competition emerges from all parts of the globe, many midsized companies are exploring ways to establish or expand their international footholds. The global marketplace can hold many tantalizing opportunities for growth, expansion and increased competitiveness. However, failing to properly understand the tax requirements of even the smallest international venture could result in big financial headaches for your midsized company.
Tax laws and procedures vary greatly from country to country, and they are constantly in flux. While tax issues rarely drive a company’s decision to go global, those issues can dictate how you go about establishing your international business. They can also play a defining role in the venture’s ultimate success or failure. Whether you plan to export a single product to Canada or build a major manufacturing facility in the Czech Republic, experts urge you to address tax issues before they take you by surprise.
The following tips may help keep your international ventures from becoming too taxing for your midsized business.
Examine Your Corporate Structure
Your company’s corporate structure can help determine what international taxes you pay. S corporations carry the highest risk of running afoul of international tax laws. If your S corp is not appropriately set up, you could find yourself in double tax jeopardy—owing taxes both in the foreign country in which you are doing business and in the United States, where you may be ineligible to claim available tax credits on incoming funds. Experts caution that even the most lucrative foreign business venture can struggle or fail when faced with a cumulative tax rate of up to 60 percent.
Additionally, countries vary widely in how they legally view U.S. limited liability corporations (LLCs) in business dealings. Canada, for example, does not recognize LLCs as having international treaty rights. Therefore, LLCs attempting to conduct business in Canada would be excluded from the benefits of the U.S.-Canada Income Tax Treaty that provides for lower (or no) income-tax withholding on certain cross-border payments.
Beware of Indirect Taxes
Just as companies doing business in the United States must collect
and report sales tax, make sure you know what indirect taxes each company you do business with is required to collect. Some common indirect taxes include:
- Value-added tax (VAT): Companies doing business in European
countries must contend with VAT requirements, and most other countries have their own equivalent as well. Unlike sales tax, value-added taxes are levied at every level of production, from sourcing to manufacturing to selling. Often, tax credits (VAT paid on purchases) are available to compensate companies for some or all VAT expenditures.
- Customs duties: These can vary both by country and by product.
Make sure you are set up to pay the required duty and file any requisite paperwork.
- Environmental taxes: Environmental taxes and other local taxes may vary by region or jurisdiction as well as by country. Be careful to investigate all local taxes that may apply.
Consider an IC-DISC
Is your business a closely-held corporation and primarily owned by individual taxpayers? Does it produce more than 50 percent of a product in the United States? If so, you could be eligible for a permanent 20 percent tax savings by creating an Interest Charge-Domestic International Sales Corporation (IC-DISC). An IC-DISC is a tax-saving vehicle. Qualifying for this requires little in the way of infrastructure in a foreign country to obtain the associated tax benefits. An old export tax benefit is now more attractive because of lower income-tax rates that didn’t exist a few years ago. Your company cannot take advantage of these IC-DISC benefits until forming the IC-DISC, which is a very simple procedure.
Understand Withholding Taxes
Many companies venturing into foreign markets for the first time are unpleasantly surprised when hit by local withholding taxes. Virtually every country has a withholding tax regime. If your company does not have a physical presence in a foreign country, and you are not protected by international treaty or another means, you could easily find yourself owing significant withholding taxes on your gross income. Experts advise you to investigate all taxes which may apply to a venture before deciding whether it will boost your bottom line or land you in the red.
For example, a contractor does some construction work for a client located in a country where the contractor does not regularly conduct business. If the project costs $1 million and generates $100,000 profit after expenses, the contractor might still have to pay withholding tax of, perhaps, 30 percent of the $1 million gross—leaving them with an unexpected $300,000 tax bill. Properly setting up the foreign business in the beginning will usually prevent unpleasant tax surprises.
Evaluate Transfer Pricing
A transfer price is the amount of money that one unit of an organization charges for goods and services to another unit within that organization. When the two units are located in different countries, most industrialized nations require businesses to produce a comprehensive transfer-pricing report to prove they are charging a fair, or “arm’s-length,” price for those goods and services.
Getting a transfer-pricing report for your company’s transactions can be expensive, but failing to have the proper documentation can be much more costly. This is especially true when one country makes a transfer-pricing adjustment but an offsetting adjustment cannot be made in the other country, which is often the case. This results in a double tax on the same income. The proper transfer-pricing analysis can also help your company direct the income to the proper, most efficient tax jurisdiction. The taxpayer can use very substantial databases to find options that can help minimize worldwide income taxes.
Beware of Know-It-Alls
Because of the complex, ever-changing nature of international tax issues, be sure to seek out expert support in the country in which you do business. Some advisors may specialize in international trade with one or two countries, but nobody can keep track of all applicable laws in every country. Be sure your international tax advisor will work closely with local resources in that foreign country to ensure you reap the greatest tax advantages at the least risk. IBI