It will come as news to no one that more businesses are entering the global market, including small and mid-size businesses. A purposeful expansion into a promising market or merely a part of running many successful businesses includes business transactions with entities in foreign countries.
International business matters require a basic understanding of the tax issues that arise when doing business in foreign countries. Without a clear picture of the tax ramifications of certain activities, you could be left paying significant amounts of taxes both in the U.S. and abroad or facing penalties from the IRS.
With that in mind, below you will find an overview of tax concepts relevant to international businesses. For specific legal and tax advice, consult with an experienced tax attorney familiar with international taxation matters.
The U.S. and many other countries tax international businesses based on “permanent establishment.” A permanent establishment does not necessarily mean you own, lease or otherwise have a physical presence in a foreign country. Instead, the U.S. has tax treaties with most countries in which you will operate that set the conditions under which you are considered to have a permanent establishment in a foreign country.
In some cases, understanding these requirements can help you avoid permanent establishment.
Transfer pricing is among the most important issues you must address regarding international tax obligations. Transfer pricing occurs when two companies under the same umbrella trade with each other across borders. The IRS will audit companies suspected of transfer mispricing. That is why it can be important for businesses to understand the difference between the European value added tax and the U.S. income tax, as just one example.
Income your business earns abroad may or may not be taxed in the U.S.
If the business entity through which you are conducting operations is a foreign corporation, U.S. tax is generally deferred until income is distributed through dividends or otherwise “repatriated” to U.S. shareholders.
As a reaction to many U.S. corporations which subsequently deferred significant tax benefits, Congress enacted Subpart F. Under Subpart F, tax deferrals are eliminated on some categories of foreign income.
Also, keep in mind that the U.S. generally does not tax corporations which do not receive income in the U.S. or conducts business in the U.S. However, all U.S. citizens must pay income tax, regardless of the source of the income.
FATCA and FBAR
In order to ensure that U.S. citizens are paying taxes on earnings from abroad, Congress enacted the Foreign Account tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR). While the full extent of compliance with these acts are beyond the scope of this article, be aware that the U.S. continues to aggressively collect on foreign-earned income for U.S. citizens.
Social Security taxes and withholding taxes
Paying withholding taxes on employees working outside of the U.S. can be complex. The good news is that the U.S. has treaties with 21 other countries regarding withholding taxes such as Social Security and Medicare that attempt to avoid double taxation for social welfare programs.
Questions? Contact an experienced international tax law attorney
This brief introduction is provided to indicate initial considerations for businesses expanding abroad or who are receiving income from foreign subsidiaries. This article is not legal or financial advice. For questions regarding how you can best use tax deferments for foreign subsidiaries, avoid permanent establishment, or otherwise manage your tax obligations, contact Janathan L. Allen, APC.