What is the best international tax strategy for the United Kingdom, Deutschland, and Français Business owning a U.S. subsidiary corporation?
The answer is long and complicated. So, please get a cup of tea or coffee and spend a few minutes. One choice is for the U.K., German or French company to merely open a branch in the U.S. and not form a U.S. corporation.
Legally; this is easy. The company will register with the state(s) where it is doing business. If it has employees, it will register with both the IRS and the states.
The other choice is for the U.K., German or French company to create a subsidiary corporation in the state that will be their U.S. headquarters. If it has employees, it will register with both the IRS and the state.
The U.S. corporation pays income tax on its worldwide income. The maximum U.S. corporate tax rate is 35% (as of October 2017). This rate may drop to 20% starting in 2018.
Most states also have an income tax. So far, it is simple. However, with more than 1,000,000 pages of tax law, it quickly becomes complex.
We start with capitalizing the corporation. American tax law is anti-debt and especially shareholder debt.
For example, Keith’s U.K. company starts a California corporation. The U.K. company invests $1,000 in the common stock and loans a $100,000 to the corporation. The loan is evidenced by a written promissory note and has a reasonable interest rate. The promissory note was approved by the directors of both companies.
The California corporation had a successful first year and paid back the $100,000. The U.K. company has $100,000 of U.S. taxable income. Yes, the repayment is taxable.
Why is the loan repayment taxable? The California corporation was “thinly capitalized”. For the U.S. standpoint, a loan is treated as preferred stock when the loan exceeds 33% of the capital (including retained earnings). This tax law is called debt versus equity. This link has more information.
And there is more bad news for international debts. If tax treaty exempts the interest income from U.S. tax, a U.S. corporation cannot deduct only a portion of the interest expense. This law is complicated, and I have an explanation on this page.
The goal of this law is to prevent the foreign person from removing money from a U.S. corporation free of U.S. income tax. Luckily, the tax treaties with the U.K., France, and Germany require a U.S. tax and thus interest paid to a residence in this country is not affected by this law.
Avoiding Double Taxation with an International Tax Strategy for the United Kingdom, Deutschland, and Français Business owning a U.S. Subsidiary Corporation or a Branch.
The U.S. tax law wants double taxation on all corporate profits. For the foreign corporation with a branch, this tax is called the “branch profits tax”
The tax law expects the corporate profits to be paid the shareholder as a dividend. The U.S. tax rate on a dividend paid to a foreign person is the lower of 30% or the rate found in the tax treaty.
The rate is between 5% to 15% for in the U.K., France and German tax treaty (please see more on this link). The tax is withheld by the paying domestic subsidiary.
For example, the California corporation had a successful first year. The business made $250,000. The U.S. tax is $80,000, and the California tax is $22,000.
The U.K. company pays out the remaining profit of $148,000 to the UK parent company. U.S. tax law classifies this as a dividend. Assuming that the ownership of the U.K. company qualifies for the U.K.-U.S. Tax Treaty for the direct dividend rate, the U.S. tax is $7,400.
The California corporation withholds the $7,400 and pays $7,400 directly to the IRS. The U.K. parent company receives $140,600 ($148,000 minu $$7,400). By the way, many types of payments of U.S. source income to a foreign person require the tax to be withheld and paid directly to the IRS. Here is a link with more on this topic.
How about foriegn management fees, consulting fees, and other stewardship fees?
Unlike other nations, you can go to prison for paying these fees unless you can prove that the foreign person did work and the payment is reasonable (read more on this link).
The U.S. courts will want to see your time journal (showing what you did, the day you did the work and the time you spent), proof that the hourly rate is valid and the business reason as to why the foreign person did the work and not someone in the United States.
How about international licensing the technology or a trade name or a trademark?
Much like the payment of fees above, you need to have proof as to the value to the U.S. corporation. When the amount of the licensing payment is inflated, not only is the deduction disallowed, the event may be considered a crime.
You must be able to prove that the price paid for goods, services and licensing is the price that an unrelated person would pay.
International Tax Strategy for the United Kingdom, Deutschland, and Français Business with a Cost Sharing Agreements to Shift Profits
Cost sharing is a sophisticated international tax strategy. The courts continue to uphold international tax planning using cost sharing agreements. You can learn more on this topic on this link.
What if the U.S. corporation does not pay a dividend?
A second corporate tax applies when a corporation does not have a business reason for not paying a dividend to a shareholder. In the example above, if the profits are needed to expand the business, for a cash reserve for unforeseen events, then the second tax will not apply.
Assuming that the U.K. company ownership qualifies under the tax treaty of the five percent rate on dividends, then the second tax is five percent.
Does the U.S. subsidiary corporation causes the U.K. company to pay U.S. income taxes?
It might! Here is what has happened, on this link.
Finally, there is the U.S. estate taxes for the non-resident alien.
Assuming that Keith is the sole shareholder of the U.K. company, the value of the California corporation could be subject to U.S. estate taxes upon his death. Here is more on this topic.
If you would like to discuss your plans of opening an office in the United States, then please email me at [email protected]