If your company is working globally, or planning to, it is important to include tax planning into your business plan. Below is a list of international tax considerations:
The interest-charged domestic international sales corporation (IC-DISC) is an increasingly popular tool used by exporters. The IC-DISC is a corporation formed by the owners of the exporter. The exporter pays commissions to the IC-DISC and receives a tax deduction for the commissions. If structured properly, the IC-DISC does not pay income tax on the commissions received from the exporter. The IC-DISC pays a dividend to its owners at the qualified dividend rate of 23.8% (which assumes the taxpayer is in the highest individual tax bracket and the full amount of the dividend is subject to the Medicare contribution tax). Therefore, the exporting entity receives a deduction at ordinary rates and the individual owners of the IC-DISC receive income at long-term capital gain rates. Assuming taxpayers are in the highest marginal tax brackets, this provides a reduction in tax of 15.8 percentage points if the manufacturing entity is a flow-through entity. The savings can be even higher if the manufacturing entity is a C corporation.
There is flexibility when computing the commissions earned by the IC-DISC. Exporters typically choose between the 4% of gross receipts method and the 50-50 combined taxable income method. Different methods may be used for different products in order to maximize the benefits from the IC-DISC. For example, the IC-DISC may compute commissions on a product with a higher profit margin using the 50-50 combined taxable income method. However, for a product with a lower profit margin, the IC-DISC may compute commissions based upon the 4% of gross receipts method.
In order to qualify as an IC-DISC, the corporation may only have one class of stock, and the outstanding value of the stock must have a par value of at least $2,500. The corporation must have the same tax year as its principal shareholder and must make an election to be treated as an IC-DISC. Additionally, 95% of the gross receipts of the corporation must be qualified export receipts and 95% of the assets must be qualified export assets. The export property must be produced, grown or extracted in the U.S. by a person other than the IC-DISC. The export property must be held for sale, lease or rental for direct use, consumption or disposition outside of the U.S. Finally, no more than 50% of the value of the final costs can be attributable to foreign components.
Structuring International Operations
If you are doing business in a country that has a tax treaty with the U.S., generally you are not subject to income tax in that country if you do not have a permanent establishment. A permanent establishment is created when you have a place of management, an office, a factory, etc. located in the foreign country. Also, using a dependent agent in the foreign country will create a permanent establishment. Avoiding permanent establishment in a treaty country will lessen the U.S. tax compliance burden on your company. However, if the U.S. does not have a tax treaty with the foreign country, you may be subject to tax in that country for merely carrying on a trade or business in that country.
If you create a permanent establishment in a treaty country or plan to carry on a trade or business in a non-treaty country, you will need to decide how to structure the international operations. There are several options including creating a foreign branch or a foreign subsidiary.
Profits earned internationally are currently taxed in the U.S. when you conduct your international business as a branch. Any taxes paid internationally can be used as a foreign tax credit to offset your U.S. tax liability. Operating as a branch allows any foreign losses to offset U.S. profits.
If you create a foreign subsidiary, foreign profits are generally not taxed in the U.S. until repatriated (usually in the form of a dividend). No foreign tax credit is allowed for taxes paid in the foreign country, and foreign losses do not offset U.S. source income. Companies that choose to create a foreign subsidiary must consider transfer pricing issues when there are transactions between the U.S. parent company and the foreign subsidiary. Lastly, there are several provisions in the Internal Revenue Code that require your foreign profits to be taxed in the U.S. if you have certain types of income or transactions, even if profits have not been repatriated. Caution must be exercised not to trigger one of these provisions inadvertently.
When deciding how to structure your international operations, you should consider weighing deferral versus the overall effective tax rate. MarksNelson can assist you with this analysis and can provide ongoing international tax compliance through our relationship with the Leading Edge Alliance. If your company has begun to consider doing business internationally, we encourage you to be proactive and create an international tax strategy before you begin doing business abroad.
For more information contact your MarksNelson professional at 816-743-7700.