Entries Tagged 'Outbound (from the U.S.)' ↓

This is another in the series of posts that will walk a CEO through the decision of how to make an international tax planning decision.

The first post is here. Introduction.

The second post is here. Consider only real possibilities, not possibilities that are out of bounds because of legal restructions.

The third post is here. Make your life simple when you’re doing business “there,” wherever “there” is.

The fourth post is here. Assume first that you’ll have a simple, “invisible” legal structure unless proven otherwise.

Now we’re going to talk about the “unless proven otherwise.” When is the “invisible” legal strategy NOT the best? Simple answer–when the numbers tell you so.

Recap on invisible

Up to now we’ve said that “invisible” is good. Tax lawyers call companies that are invisible “tax nothings.” They are real companies, protect you from liability and all that stuff. But the IRS treats them as if they don’t exist. It’s pretty easy to do. Take your foreign company, file Form 8832 (PDF) with the IRS, check the right boxes (of course), and your foreign company is a “tax nothing.”

Here’s some tax jargon so you can sound cool at cocktail parties (or blow your CFO’s mind) — this is a “hybrid entity.” This just means that in the foreign country your foreign company is taxed like a corporation but in the United States it isn’t. Well, there you go. Useless trivia. Go crazy with it.

The reason to use this is to get credit in the United States for the foreign taxes paid.

Alternative to invisible

Sometimes, though, the “tax nothing” / “hybrid entity” / blah-blah idea isn’t so good. Here is when.

The default mindset for the Internal Revenue Service is “If you’re American, pay tax on everything you make, everywhere, in the year you earn it.” The alternative to “invisible” is a structure that allows you to postpone paying taxes to Uncle Sam. Let’s call it the “deferral” strategy.

You are a candidate for the deferral strategy if:

Your business is growing outside the United States; and

You can absorb all of your foreign profits and plow them back into foreign operations; and

You won’t need to bring cash back to the United States to fund U. S. operations.

Let’s say you make $10,000,000 of profit outside the United States in a tax-free country. Bring it back to the U. S. using the “invisible” strategy and you pay $3,000,000.

Instead, you set up a “deferral” structure, keep the $10,000,000 in your foreign subsidiary, and use it as working capital to fuel next year’s growth.

What has happened is that the IRS has let you keep–and use–$3,000,000 that would have otherwise gone to taxes. And if you needed $10,000,000 in working capital, you’d have gone to the bank to borrow that money.

The longer you defer the day when U. S. tax is due, the better the deal. The present value of a $3,000,000 payment made 15 years from now is about 78 cents. I exaggerate slightly.

It is possible to earn profits from foreign business operations and not pay U. S. tax on those profits until you bring the profits back to the U. S.

So ask yourself. If you had an extra $3,000,000 in working capital, and you put it to work for 5 years, would that help?

Deferral is the alternative tax strategy to my starting point “invisible” strategy. In the next post I talk about how someone else–not you–is going to generate the numbers (using your revenues, your margins, etc.) to choose “invisible” vs. “deferral.”

This is a short series aimed at CEOs, so they can make good decisions about international tax planning without having to become any kind of tax expert at all. I will spot you the “T” and the “X” and if you can spell “tax” with that head start, you’ll be fine.

The first post in the series is here. It’s an introduction.

The second post in the series is here. Look for the easy answers first. Are there some roadblocks that are impossible to overcome? Resistance is futile. Accept the things you cannot change. Etc.

The third post in the series is here. Will your life be easier if you have a company in the country where you are investing or doing business? Yes, probably.

This brings you to a point where you have to encounter tax jargon for the first time. Don’t worry, it’s not as bad as you think.

I have a simple starting point for U.S. companies looking outward for investmnt or business operations. I assume it is best unless proven otherwise.

Where you have cross-border investment or business operations, my starting point is to create a legal structure (companies and all that stuff) that is nonexistent for U.S. tax purposes.

“Invisible for U.S. tax purposes” simply means that the companies you use will not pay income tax in the United States, even if they do pay tax in other countries. Partnerships work this way. So do limited liability companies and Subchapter S corporations.

And, magically, all sorts of foreign corporations fall into this category through the magic of tax law. You can make some–not all–foreign corporations disappear for U. S. income tax purposes.

The liability protection of a corporate entity remains intact. You have a locally-formed company, making it easier to do business in the foreign country.

Cheaper, simpler to run

The first reason I like this concept is that an invisible structure is usually cheaper to operate–in legal fees, accounting fees, tax returns, and the like.

Passes tax credits upstream easily

The second reason I like this is because it makes it easy for the U. S. company to take a credit (against U. S. income taxes) for taxes paid overseas. And that is the key to having a dollar of profit taxed once, not twice. You frequently don’t care WHERE you pay the tax (Germany or the United States) as long as you don’t pay it in both countries.

Next

Next, we look at times when the “invisible is best” structure is not the best. Warning: we’re going to talk about present value.

We’re talking about how you — the CEO — think through the international tax planning advice you’re getting from your CFO, your outside accountants, and your corporate lawyers.

Part 1 - the introduction - gave an overview.

Part 2 - the first step of my procedure - told you to look for knockout punches in the form of government regulations that force you in one direction or another. If government regulations require you to do business in a particular type of entity, then your tax choices are limited by those regulations.

This is Part 3.

We now come to a fuzzy-wuzzy, mumbo-jumbo, touchy-feely question:

What’s the easiest way for you to do business day-to-day with your foreign investment or business operations? How can you keep paperwork, complexity, and headaches out of your life and the lives of your employees?

For day-to-day business operations, is it easier for you to operate in a foreign country if you look “local” because your entity is formed under that country’s law? How easy is it to open a bank account? Lease an office? Hire employees?

My overwhelming experience is that forming a local company will prevent self-inflicted brain damage. Put it another way:

Usually it is easier to fit in if you look like a local, not a tourist.

How do you figure this out? Again, go talk to your foreign lawyer or business consultant. Talk about the practicalities. See what they say. Go talk to the banker about opening bank accounts. In other words, do a dry run on some of the footwork you’ll have to do anyway.

You’ll clue in fast enough as to the effect of local customs, biases, and sophistication on your decision.

You can send someone to do this for you. You might consider sending an employee who isn’t exactly your star employee. If it is easy to navigate there for an average person, then your star employees will have no problem.

An example from my own personal experience. This is an “inbound” example, where the foreign country is the United States.

I handle a lot of large U. S. real estate transactions for nonresidents. When I appear as the lawyer for the buyer (or seller, it doesn’t matter) talking about Cayman Islands corporations, complicated trusts and other new–to the title company and escrow company and broker and lender–entities, we sometimes run into practical problems in getting transactions closed cleanly.

Knock on wood, my transactions have always closed, and they always close on time. But sometimes the costs of doing so are higher because the other side in the transaction has never seen a Cayman Islands corporation in real life. Or they don’t know the basic A-B-C’s of tax withholding on foreign sellers of U. S. real estate.

If, on the other hand, I come in and announce a structure where my client is hidden behind, for instance, a Delaware limited liability company, all brains go to sleep, the cats purr contentedly, and we close the transaction without a hitch, on auto-pilot. :-)

If you can’t guess, I like using local companies for business operations

Next we’re FINALLY going to talk about tax. I can sense your excitement.

When I work with a U. S. company that is going to do business outside the United States, here is where I start. I want — as quickly as possible — to move from infinite potential to plausible reality. Let’s only consider things that might really happen. Then let’s choose the best we can.

The first thing I do is look at stuff out of everyone’s control. That means, first, government regulations. Look at your home country (USA) laws. Look at the country where your company will be doing business. Are there any laws (employment laws, licensing rules, rules limiting foreign ownership, etc.) that force you to choose a particular type of legal structure? If you have this situation, well I’m sorry, but the somebody has already dealt the deck and you have the cards you were dealt.

Here is an example that is completely non-international. But it is simple and demonstrates what I’m talking about.

Law firms in California may be corporations, general partnerships, or limited liability partnerships. They may not operate as limited partnerships or limited liability companies (LLCs). That’s what California law says. So when a California law firm is formed, there are limits on what can and cannot be done. As much as you might want to use an LLC, you can’t.

Is there something analogous for your business that will deliver a knockout punch in Round 1? For this, you need someone smart in the country where you will be operating. Get that answer first in order to prevent a lot of wheel-spinning by your U. S. lawyers and accountants.

And when you ask this question of your foreign lawyer, ask it very specifically. Ask strictly about regulatory and legal restrictions that mandate doing business in one fashion or another. You will have many other questions later. But don’t confuse your advisor by asking him/her too many questions at once. Ask the right questions, ask them specifically, and ask them in the right order.

Yeah, I know. Not very technical. So sue me. This approach saves time, money, and brain cells.

I am going to throw a series of posts here that are aimed at U. S companies that are expanding their business operations overseas.

I’m talking to CEOs here. People who need to make decisions.

If your business operations have a border running through them, then your CFO and accountants have all talked to you about international tax. How on earth are you going to make sense of all this arcane gibberish you hear? Subpart F. Transfer pricing. You know they’re talking in English but how can you fit all of that conversation and advice into a decision model and move forward with your business decisions? And how do you know if you’ve made a sound decision.

You’re busy. You need to understand the big picture, make a decision, pass implementation along to someone you trust, and be able to know when they’re done with the job. All without incurring brain damage.

(There’s nothing worse than trying to force a CEO to become an instant international tax expert.)

This series will describe how I work my way through tax planning for cross-border business deals and business operations. I hope the methodology is useful for you, and helps you frame the problem and choose a course of action.

And I will never mention tax at all. What never? Well, hardly ever. OK. We’ll keep it to a minimum–just so you can understand what the High Priests of Tax are jabbering about. (And you can call BS on ‘em, too).

Tax Analysts has a small article about U.S. baby boomers retiring outside the U.S. There are some tax benefits (relatively small, usually) that are highlighted in the article.

In our practice we see some of this. The tax angles are usually secondary to the clients we work with who move out of the U.S. After all, as long as they maintain U.S. citizenship they are taxable on their worldwide income. (One benefit, though, is that they get away from State income taxation). But usually the key motivating factor is the ability to buy a lot of lifestyle at the same amount of money.

We rarely see people willing to give up citizenship (or legal permanent resident status) simply to avoid the U.S. tax bite. In fact, I had that very conversation with someone last week. The tax benefits are simply not enough to justify foreclosing all of the benefits of having the U.S. passport or green card.

For the few who want to do this, we walk them through the process and structure their financial affairs to minimize or eliminate U.S. tax bites after they give up their passport/green card and leave the country.

In that sense, giving up citizenship to save taxes is a lot like asset protection trusts–far more frequently talked about than done.

More common–for our tax advisory practice, anyway–is the U.S. business executive who moves abroad for a period of time, intending to return after a few years.