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International Tax Code for Small Business Importing, Exporting & Ecommerce

The International Tax Code for Small Business Importing, Exporting & Ecommerce just got much much better.  The new tax laws allow small business to avoid U.S. income taxes on their foreign source income.  So now, the new challenge (and maybe the only challenge) is designing the business activity to have foreign income.

For some businesses it is not difficult. For other business it will be almost impossible.  This blog post has the basic concepts.   Please use these concepts, below, as a discussion point with your CPA and/or attorney.  Also, you can learn about some easy foreign corporation tax planning on this link.

Small business international tax plan will include a foreign corporation.  E-commerce businesses will want a tax haven corporation.  My two favorites are the Isle of Man and the British Virgin Islands.    The two countries have different economic systems that will affect your choice.

The international tax code has little effect on your choice.    The new  international tax code allow small business to avoid U.S. income taxes on their foreign source income.   The  international tax code does not care where the foreign corporation is formed.

If Europe is your market, then the Isle of Man is best.  The BVI is the best for markets other than Europe.  The reason is the VAT (value added tax).  This tax is in all of Europe, the U.K. and Canada. Compliance is easier in the Isle of Man.  Also, the Isle of Man has solid electrical grid.

The BVI has good corporate laws.  However,  you do not want to place your computer server in the BVI.  Their electric grid is not dependable.

The new  international tax code is dependent upon foreign source income. I have the general rules below (each rule has exceptions so consult your CPA)

Summary of the General Source Rules for Income of  Foreign Corporations and Nonresident Aliens.

 Item of income

   Factor determining source

Salaries, wages, other compensationWhere services performed
Business income: 
 Personal servicesWhere services performed.  This includes some E-commerce websites providing information or a service.
 Sale of inventory—purchasedWhere sold.  One of the key points is where the change of title to the inventory occurs. Contact your CPA.
 Sale of inventory—producedAllocation – this law is more complex.  Contact your CPA or me. 
InterestResidence of payer
DividendsWhether a U.S. or foreign corporation*
RentsLocation of property
 Natural resourcesLocation of property
 Patents, copyrights, etc.Where property is used
Sale of real propertyLocation of property
Sale of personal propertySeller’s tax home (but see this special IRS report on  Personal Property, for exceptions)
Pension distributions attributable to contributionsWhere services were performed that earned the pension. See the new IRS tax planning on this link.
Investment earnings on pension contributionsLocation of pension trust.  The IRS just issued a new tax savings ruling on this topic on this link.
Sale of natural resourcesAllocation based on fair market value of product at export terminal. For more information, see section 1.863-1(b) of the regulations.
*Exceptions include: a) Dividends paid by a U.S. corporation are foreign source if the corporation elects the American Samoa economic development credit. b) Part of a dividend paid by a foreign corporation is U.S. source if at least 25% of the corporation’s gross income is effectively connected with a U.S. trade or business for the 3 tax years before the year in which the dividends are declared.

International Business Income Amazing Tax Savings

The amazing tax savings of international business income has been used by firm such a Google, Amazon, Ford and other big businesses for a century.

So, my question is why small business is missing out on the tax savings?  Surely, some must have international business income.

What are the tax savings of international business income?

No U.S and no state income taxes for a start.  And there is more in the form of compounding growth.   Privately owned businesses do not have access to capital (money) from the public.  Money is from banks (yuk) or  from after tax profits.

The faster a business grows, the more money it needs to cover increase payroll, more rent and the cost of additional inventory.   Bank debt is risky because a few slow paying customers can cause you to go into default.

After tax profit is greater when the tax is smaller.  International business income can be taxed at zero; however, the usual tax rate is about 17%.

Ian has a business in the United States and in Canada.   They both make $100,000 a year.   With a 15% Canadian tax, the Canadian business has $85,000 after tax to purchase more inventory.

Back in the United States, with a combined U.S. and state tax rate of 40%, the business has only $60,000 to purchase more inventory.

The Canadian business sales more inventory because it has more inventory.  The profits keep compounding faster in Canada.

The Zero percent tax rate applies to international business income from  ecommerce businesses that sale intangibles (such as travel services, music, cloud storage, e-books, entertainment and information).

These business’s hub is their computer server.  The source rules (on this link) provide that many (not all) e-commerce income is foreign source when the computer server is located outside of the United States. 

E-commerce tax planning is new only because ecommerce is new. 

International business income from intangibles has unique tax laws.  With property planning,  the international business income can be foreign source income.   I want to emphasize proper planning.

Planning needs to start when you start the business.  When  a firm like Google plans  a new product, they have also  completed the tax plan.   While small businesses start the business and bungle along until year end.  Then they discover they owe lots and lots of tax.

If you want to learn more, then please check out this blog on the topic.

Source of Income for International Tax Strategies

Source of Income for international tax strategies is used by international tax accountants in foreign tax planning.

The sourcing rules can create a wall between a foreign corporation and the IRS.  Of course, the foreign corporation wants to be on the side of the wall that is outside of the United States.

Most foreign source income is not subject to U.S. income taxes.  However, there is a small exception involving the sale of inventory property. 

Here is a chart of the sources of income for international tax strategies.

Item of subject to source ruleGeneral rules of source of income  for international tax strategies
Salaries, wages,Where services performed
Business income—personal servicesWhere services performed
Sale of inventory—purchasedWhere sold
Sale of inventory—producedAllocation of a variety of factors
Sale of personal propertyWhere title passes, with exceptions
InterestResidence of obligor-payor
DividendsDomestic if domestic corporation & foreign if foreign corporation
RentsLocation of property
Royalty—patents, copyrights, etc.Where patent or copyright is used; laws are vague
Sale of real estateLocation of property
Personal service, consulting, training,Where serviced performed
PensionWhere services were performed that earned the pension

Source of Income for International Tax Strategies for the service business.

For example: Ian is a member of a U.K. law firm.  The law firm has an office in Florida.  This office promotes the law firm’s Cayman Island’s office.  Ian manages the Florida office along with two other partners and two secretaries. 

In Florida, Ian and his partners meet with clients, potential clients, manage the operation and accounting of the Cayman office.

Often Ian and the other partners travel to the Cayman Islands to work with the attorneys in the Cayman office.

The Florida office has a local bank account.   

Under the U.S. international  tax accounting  sourcing rules, the U.K. law firm has no U.S source income.  Having an office (or what is known as a “permanent establishment”) is irrelevant when the income is from a service.   The U.K. law firm does not need to file an U.S. tax return.  

However, a protective filing of a U.S. tax return should be considered.

Foreign source income for international tax strategies.

The partnership income is foreign source for U.S. international tax accounting purposes. 

American tax law ignores the place of banking, the existence of an U.S. office or permanent establishment. 

The one factor that determines U.S. taxation is where Ian and his partners do their billable client work.    In this case, the legal work is performed in the United Kingdom and the Cayman Islands. The legal work is foreign source income. 

 Learn why Ian does not pay income tax in the U.S. on his income on this link. 

Looking for help with your understanding the source income for international tax strategies and planning?  Then, please contact me, Brian Dooley, CPA, MBT via email (at [email protected] ). 

By the way, here is a method to generate more foreign tax credits.

IRS International Wish List of Updated Foreign Income Tax Planning Laws

Domestication of a foreign trust

Applying for an IRS ruling on your international tax planning will save you taxes in the long run.

With little money to spend on attorneys to draft new regulations and rulings,  (because of the Republican Party’s cut in IRS funding), the international tax division has a short wish list. Here is the list:

1. Guidance under section 954(c), including regarding foreign currency gains.
2. Guidance under section 954, including regarding foreign base company sales and services income. [See T.D. 9733.]
3. Regulations under section 956 regarding the treatment of loans to foreign partnerships and related issues. [See T.D. 9733; REG-155164-09.] This is a hot topic to the IRS. This loophole has existed for fifty years, but the IRS learned about it just recently.
4. Final regulations on the treatment of upfront payments on swaps under section 956. Temporary and proposed regulations were published on May 8, 2015. This is a sophisticated tax saving strategy. If you have a controlled foreign corporation, this method is worth exploring.
5. Final regulations under section 959 on previously taxed earnings and profits. Proposed regulations were published on August 29, 2006. Please note, the IRS started this project a decade ago.
6. Final regulations under section 964 on accounting method elections. Proposed regulations were published on November 3, 2011. This is a KEY international tax planning law. If your CPA has not helped you, then you can contact me.
7. Guidance under sections 1295, 1297, and 1298 on passive foreign investment companies. Proposed regulations regarding foreign insurance companies were published on April 24, 2015. Temporary and proposed regulations regarding reporting requirements were published on December 31, 2013. Another major loophole that the IRS just recently discovered. It has been around for decades.

Some of these topics have been on the IRS wish list for almost a decade.  As you read this list, you can see tax strategies that continue to save you money. 

IRS is Gunning for Small International Businesses with Bad Bookkeeping

International tax planning and strategy

Applying for an IRS ruling on your international tax planning will save you taxes in the long run.

IRS National Office international tax specialist, Anne P. Shelburne, Esq. knows her stuff.  She knows that the Achilles’ heel for small business is that they go “cheap” on bookkeeping.

The best international tax plan crumbles without “books and records” (the term used in the tax law) to support the plan.

This is great for her because, as you will read below, she informs the IRS auditors and special agents that all income is U.S. source unless the taxpayer can prove the amount is foreign source.  That is right.  You lose and they (the IRS wins).  In America, when it comes to civil tax audits, you are guilty!  You have the burden to prove your innocence.

There are other reasons for good bookkeeping.  Here are a two:
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