Posted by Stephanie L. Chapman, CPA
Does your foreign company sell products online to American customers? Are you interested in accepting payment in US dollars? If so, it may interest you to learn that to do so you must establish a U.S. based entity that can accept the payments through a U.S. bank account. When contemplating doing business in the U.S., there are several issues to consider that will impact your tax situation. After all, leveraging your products in the U.S. will have little meaning if the profits are lost to taxes. For this reason proper planning is critical to establishing an effective international framework. To help our clients and prospects understand the complexity of the process, Belfint Lyons & Shuman has provided below a list of key issues to consider in the process.
Doing Business in the U.S.
Below we have outlined important items to consider prior to beginning the process. These include:
- Existing Tax Treaty – Before establishing a business entity in the U.S., it’s important to determine if a tax treaty exists between the US and the company’s home country. Tax treaties are formal agreements between the tax authorities of two countries (or in some cases multiple countries) to reduce double taxation on income earned by a resident of either country. Generally speaking, tax treaties include specific details on income tax, inheritance tax, and value-added tax rates for companies operating in both countries. Many new business owners are surprised to discover that income may be taxed at both the standard rate in the U.S. and in the home country if a tax treaty does not exist. For this reason it’s essential to understand the tax agreement between the U.S. and the home country prior to formation.
- Permanent Establishment – When forming, your company’s permanent establishment is an important factor to consider in tax planning. This is a term that denotes any fixed place of business that gives rise to income or other tax liability from business operations in that country. While each tax treaty defines permanent establishment differently, generally speaking it includes but is not limited to a factory, warehouse, management office, branch offices, and U.S. employees. In other words, permanent establishment is generally created by a physical presence in the country in which the company carries out its business activities. When contemplating formation it’s important to consider permanent establishment because doing so may create additional tax liabilities. For companies forming in a country for the purpose of opening a bank account, permanent establishment is generally not created unless a place of business is obtained.
- State of Formation – In the U.S., companies are formed at the state level. Each state has different rules, regulations and processes for how companies are established, what fees are assessed, and which taxes they are subject to. Some states have more complex rules and fee structure while others have less. For this reason, when determining the state of formation, it’s recommended to select a state that offers the most “business friendly” environment. Delaware is a very popular option because its laws allow a great degree of flexibility when managing a business. The state is considered tax-friendly and the courts have a well-developed case law history and corporate law expertise. In addition, a Delaware company can be formed very quickly, in some cases within 48 business hours or less.
- Federal Taxation on Worldwide Income – Although incorporating in Delaware can in certain circumstances reduce or eliminate taxes at the state level, the U.S. also assesses tax on entities at the federal level. The U.S. is unique from most other countries in this regard; its citizens, residents and corporations are taxed on their worldwide income, as opposed to just income derived from U.S. sources. In such cases, foreign tax credits are generally permitted for taxes paid to other countries on the same income. However, limits may be imposed on such credits.
- Entity Selection – There are several entities to select from when establishing a U.S. company. In Delaware you can select from sole proprietorship, LLC, general partnerships, and C-corporations. S Corporations are available only to U.S. Citizens or Permanent Residents. The type of entity you select will determine how income is taxed at the entity level, how profits are transferred to owners, and the resulting taxing process. When selecting the entity type, carefully consider the operating and taxation rules for each to determine the best for your situation.
- Number of Owners – The number of owners in a foreign-owned U.S. company plays an essential role in determining how taxes are paid and at what rate. If a company is owned by several foreign individuals from different countries, the tax issues can become quite complex. Remember, the way taxes are determined for each owner is dependent on whether tax treaties exist and the specifics of each. However, if a single foreign individual owns the company, the tax issues are generally less complicated and easier to calculate. For this reason it’s vital to carefully consider the number of owners for your company.