The increasing globalization of the economy is resulting in more small and medium-size businesses seeking to expand internationally. While companies are extending their products and services across borders, many don’t consider the compliance and planning issues that come with doing so.
Beth Van Leeuwen, CPA, tax manager at MarksNelson, said that more and more businesses are setting up subsidiaries overseas, or the businesses themselves are being purchased by a foreign person or company.
“Our clients want to diversify where they’re selling, and for clients already established domestically and who think they can be more successful, going overseas is the next step. Also, in many cases, it’s cheaper to produce a product overseas, or to complete the routine labor and ship the product back to the U.S. to finalize it. They’re going international to increase revenue.”
Van Leeuwen believes it’s important for businesses that are considering going international to take appropriate tax planning measures. “In a lot of these transactions, the business owners don’t realize what some of the tax issues are until they run into problems,” she said.
In order to zero in on the issues a business should weigh in making the decision to spread its wings abroad, Van Leeuwen has come up with six questions owners should ask:
1. Will I send my employees abroad? “If you’re sending employees abroad, you have to know if there is an income tax treaty with the country involved,” she said. “Then you look to the terms of the treaty to see where and how the income is taxed. For example, if they’re there less than a certain number of days or they earn less than a certain amount, it won’t be taxed. If they exceed that, you have to go with what the country’s tax laws dictate.”
“For example, a U.S. citizen who is a nonresident of Puerto Rico and who is married living with a spouse must file a Puerto Rico income tax return if he or she has gross income from Puerto Rico over $5,000, unless the taxes have been totally paid at the source. If the U.S. person is working in Puerto Rico, those wages are considered to be Puerto Rico source wages.”
2. When I make payments to foreign companies or people, are there any withholding and/or reporting requirements? “A lot of people don’t think about this,” she said. “There’s a default withholding rate of 30 percent on Fixed, Determinable, Annual, or Periodical (FDAP) income [including interest], unless a lower treaty rate applies. Even if there’s no withholding because a treaty provision applies, you have to have Form W-8BEN [Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding] available. For instance, a U.S. company making interest payments to a Portugal company, if withholding is zero, under the treaty the U.S. company doesn’t have to withhold, but would have to have the W-8BEN on file.”
3. Where am I doing business? “It’s surprising how many companies this can impact,” she said. “What the U.S. is looking for is which U.S. companies are doing business with countries that boycott Israel. If you are, there is a calculation involved and you will lose a portion of tax benefits.” The penalties are stiff for failing to comply with reporting requirements, Van Leeuwen indicated. “If you’re just buying products there, if there’s a willful failure to file, the penalty is $25,000 and up to a year in prison.”
4. Will I open a bank account in a foreign country? If so, annual reporting is required through the Bank Secrecy Act for U.S. persons, Van Leeuwen indicated. “If you have a financial interest in or signature authority over a foreign financial account, the Bank Secrecy Act requires you to file a report yearly to the IRS on Form 8938 [Statement of Specified Foreign Financial Assets]."
"People sometimes think this applies to overseas countries, but they don’t think of it applying to Mexico or Canada," she added. "For example, a U.S. citizen who works in Canada may have a foreign retirement plan, and be required to file Form 8938.”
5. Do I plan to have ongoing operations in a foreign country through a foreign division or subsidiary? “Depending on how the business is structured, a lot of times you have the ability to choose how you will be taxed in the U.S.,” she said. “You can set up as a controlled foreign corporation (CFC) and leave money overseas. There is no tax until the profits are repatriated back to the U.S.”
“Most entities can make a check-the-box election to be a disregarded entity for U.S. tax purposes, in which case the business would be taxed like a partnership,” Van Leeuwen added. “A lot of people don’t realize there is a choice, and depending on the rate in the other country, you can do some nice planning to see which entity is best for you.”
6. Have I considered other types of taxes, such as value-added or duties? “Businesses should know the different types of taxes countries have, as they all come with certain requirements,” she said. “It’s like a sales tax issue. If you don’t consider it and don’t file a return, you haven’t started the statute of limitations, so liabilities add up. And in some cases, they may be entitled to a refund.”
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