Tax Planning for Foreign Companies
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How Tax Planning for Foreign Companies Works?
Multinational firms and partnerships are subject to a variety of tax systems in the countries where they have a presence or conduct business.
The United States claims jurisdiction over foreign corporations only if they conduct business in the United States or earn income from sources in the United States. Foreign corporations that conduct a trade or business in the United States are liable to net-basis income taxation under Section 882 on any income that is “effectively connected income” which the company generates. Such corporations may also be subject to Section 884’s branch taxation scheme. Furthermore, whether or not a foreign corporation is engaged in a business in the United States, all foreign corporations are subject to gross-basis tax under 881 on certain types of U.S.-source income — primarily investment income, such as dividends — that are not “effectively connected” with a U.S. business.
Form of Organization
There are various ways for a foreign corporation to conduct business in the United States. The precise legal structure that the US operation will take is frequently determined by the nature of the business and the magnitude of the proposed operation. The following are some of the options for the organizational structure of the US operation:
- Partnership or Limited Liability Company (LLC)
Tax Planning With Gamburg CPA PC
For most foreign companies, the most pressing question is likely to be: “How will the income or gain from my investment be taxed in the U.S.?” This is an income tax consideration. With respect to the income generated by an investment, the answer lies in the type of income that the investment is producing. Foreign investors are only subject to U.S. income tax on their U.S. sourced income, and that income can be divided into two main categories: (i) passive income (things like interest and dividends from passive investments); and (ii) active income (income that is related to, or connected with, an active trade or business in the United States). In tax terms, these types of income are respectively referred to by the acronyms “FDAP” or “FDAPI” (which stands for fixed, determinable, annual, or periodical income) and “ECI” (which stands for effectively connected income).
If you are a non-resident business owner, the U.S. Internal Revenue Service (IRS) will tax you on income that is sourced in the U.S. If your business is incorporated in the U.S., you may also be required to pay an annual fee to the state where your business is incorporated.
In the case of FDAPI, foreigners are generally subject to U.S. income tax under a withholding regime in which a 30% withholding tax is imposed on the income at source. Importantly, this withholding tax applies on a gross basis, meaning that deductions cannot be taken to offset the income. There are reduced rates available in various tax treaties with certain countries.
Strategic tax planning is required to compete in a competitive market. Foreign companies who do not undertake strategic tax planning will face a significant competitive disadvantage in the global marketplace. When a rival joins a market with a higher tax rate, they must sell higher-priced items while earning less money.
Foreign corporations that are inexperienced with international tax laws, cross-border transfer pricing rules, and double tax treaties are significantly more prone to pay excessive foreign tax charges.
Below is a list with suggestions of the most effective tax planning methods for Foreign companies:
It is a tax-planning approach in which income from high-tax countries is transferred to low-tax countries via transfer pricing of products and intangibles. It may result in a significant loss of tax revenue for the high-taxing country. In contrast, current tax payable is decreased by deferring the amount of tax paid to future periods. It is important to have a transfer pricing study done to support the costs charged by one company to another.
Since interest is a deductible expense, a high tax planning technique is the high leverage of a foreign corporation in high tax jurisdiction. Inter-group loans are a tactic for tax planning: a foreign affiliate within a tax paradise offers a loan to a high tax jurisdiction and the parent business may borrow and use this for the purpose of ‘injecting’ equity into a tax paradise affiliate. The affiliate then lends the money to a high-tax company in a country. However, this also has restrictions and limitations, and in certain cases the US tax authorities might deem the interest as non-deductible.
It is a tax planning method in which firms from a higher tax jurisdiction are shifted to a low-tax jurisdiction in order to reduce the effective tax rate. Companies opt to relocate their main operations from one country to another in order to take advantage of the less advantageous tax system. Disputes that necessitate court intervention can result in tax-driven relocations. If a company with a capital gains tax moves its primary institution to a country without a capital gains tax, it becomes a non-resident and avoids capital gains tax.
Use of Tax Havens
Foreign companies formed in tax havens are so common as a fiscal strategy that they are out of proportion to the tax havens’ economic levels. Because of their small size, tax havens account for a considerable fraction of global FDI (Mauritius, the Netherlands Antilles, and the Cayman Islands). Portfolio investment will be channeled to the country via a tax haven that has entered into a double tax avoidance agreement with the government.
The preferred tax shelter for foreign portfolio investment into US capital markets is Mauritius. There is no withholding tax in Mauritius. The domestic company tax rate applies to both types of offshore entities. The Global Business Company Category 1 is considered a resident.
It benefits from DTAAs signed by Mauritius with other countries if it holds a Tax Residency certificate. Global Business Company Category 2 is considered a non-resident entity. It can have a one-share minimum share capital. It does not benefit from Mauritius’ DTAAs. It is not required to file annual tax returns and can maintain confidentiality through the use of a nominee.
There are around 40 tax havens around the globe. They are often small, wealthy countries (often islands) with limited populations, little natural resources, and good telecommunications connectivity. The widespread notion is that they are used to hide income obtained via tax avoidance. Because tax havens lower tax collections in high-tax nations, the OECD released a list of them and pushed them to increase information sharing with other countries.
It is important to be careful with such structures as well, because certain governments, including the US, find a way to tax profits from those entities in the country’s own jurisdiction.
It is a tax planning approach in which a foreign company’s affiliate does not repatriate income from the parent firm (dividend, or interest). As a result, the parent firm pays no tax in its home country, and the affiliate pays no withholding taxes in its home country.
It is a tax planning approach that involves the exchange of corporate identities. The corporate structure is reversed, with the subsidiary becoming the parent company and the parent firm becoming the subsidiary. This process, known as ‘expatriation,’ is utilized by American corporations that want to avoid paying taxes on their international earnings in the United States. How does it happen? The worldwide method of taxation is applied in the United States. The parent firm in the United States selects a subsidiary in a country that follows the territorial approach to taxation.
This subsidiary is elevated to the status of parent, while the parent US business is elevated to the status of the subsidiary. How can this be achieved? The parent firm in the United States may establish a foreign corporation in a tax haven, such as the Cayman Islands. The shell company distributes its shares to the parent company’s shareholders in exchange for the parent company’s shares from these shareholders. Alternatively, the shell business exchanges its shares for the parent company’s assets.
The US does have a system to tax foreign corporations and make the owners of the foreign corporation pay taxes in the US. So this planning has to be carefully considered.
Tax Planning Strategies We Implement
Estate Tax Planning – Since regulations for real estates are constantly changing, we will proactively find ways to preserve you family’s wealth. This is where we will apply vigilant approaches all designed for estate management. We will make sure that your real estate tax plan is customized in a way that it will reflect your personal or business goals.
Income Tax Planning – We are not just concerned about the numbers of methods that can help make your wealth grow. With our tax planning services, careful planning is performed so you can save money. And when you do, you or your business can be set up for success.
Year-End Tax Planning – This is where we will focus on your marginal income, so we can legally minimize your tax liability. Our goal is to lower your tax bracket possible when it comes to overall income.
Are you ready to obtain success in your personal and/or business taxes?
Get in touch with Gamburg CPA PC now. We are more than happy to discuss how we can help you!
In order to do business in this economical world, foreign companies and corporations must carefully evaluate the tax ramifications of their operations. Failure to consult with an expert tax planner about such matters can result in increased expenditures due to additional taxation.