Foreign Companies Expanding in US Must Navigate Complex Tax Maze

Expanding into the US offers immense opportunities for foreign business owners, but requires careful consideration to mitigate unwanted income and other taxes.

The complexity of US federal, state, and local tax laws can produce tax issues based on type of business, legal entity structure, finance and capital considerations, and construction of supply chain. In addition, foreign businesses often don’t consider implications of the specific US location.

There are several key tax considerations for a foreign business looking to expand into the US market or invest in a US business.

Entity Structure

An appropriate entity structure helps with legal compliance and may provide liability protection. However, if the tax implications of the legal entity structure aren’t considered, there could be additional costs incurred related to tax compliance or increased tax liabilities.

In assessing the legal entity structure, a business should consider opportunities to mitigate direct and indirect tax liabilities. Also, the legal entity structure can enhance investment opportunities and facilitate efficient exit strategies by providing potential tax attributes to a purchaser. Other legal entity structure considerations may include:

Profit repatriation strategies. The legal entity structure will determine how profits can be repatriated and the associated withholding tax and reporting requirements. The availability and application of the tax treaty should be a consideration for US federal tax purposes.
Foreign entity’s employee travel to the US. The travel of employees from the foreign entity to the US can affect US federal and state employment taxes.
Income subject to US state tax. The inclusion (or exclusion) of foreign entities in the state filing groups and the impact on the income subject to state income tax.
Supply chain and impact to tax filings. The sale of goods and services from the foreign entity to customers in the US can cause state filing obligations even though a US federal filing may not be required.

Transfer Pricing

Transfer pricing is important for cross-border businesses to consider because it helps to align compliance with tax regulations, avoid double taxation, manage risks, enhance profitability, and prevent disputes.

Compliance with tax regulations. Foreign businesses must establish transfer prices that comply with their local regulations and US tax regulations to reduce risk of penalties, audits, and potential disputes with tax authorities.

Mitigate double taxation risk. By setting appropriate transfer prices, foreign businesses can allocate profits fairly between different jurisdictions. This mitigates risk of double taxation and helps manage overall tax position.

Risk management. By establishing arm’s-length prices, foreign businesses can reduce the risk of transfer pricing adjustments, which could lead to additional taxes, penalties, and reputational damage.

Enhanced profitability and cash flow. By properly reflecting the value of goods, services, or intellectual property transferred, foreign businesses can allocate profits appropriately, potentially improving overall financial performance.

Avoidance of transfer pricing disputes. Transfer pricing disputes can be time-consuming, costly, and detrimental to business operations. By proactively establishing and documenting transfer pricing policies that comply with US regulations, foreign businesses can reduce the risk of disputes and focus on their core business activities.

State Income and Indirect Tax

State income and indirect tax reporting can be complex and cumbersome. Incomplete or delinquent filings can expose businesses to higher taxes and significant penalties, and failure to file state and local tax returns could affect the purchase price if it arises during tax due diligence upon sale of the business.

State and local tax law can differ from US federal tax law. A foreign business beginning or expanding into the US should proactively obtain proper advice about filing obligations and reporting tax to the appropriate jurisdiction to mitigate potential penalties.

Here are some additional considerations.

Compliance with state tax laws. Each US state has its own tax laws and regulations. Additionally, states aren’t uniform in the types of taxes levied on business. A state could impose some or all of the following taxes: income, gross receipts, sales, use, personal property and real property.

Most states don’t conform to protections provided by tax treaties. As such, a foreign business could have different tax profiles for US federal and state tax purposes. Foreign businesses must comply with these requirements to manage their tax burden and reduce the risk of significant audit assessments (including additional tax, penalties and interest).

Tax nexus. State tax reporting obligations arise by a business’s contacts (nexus) with a state or locality. A business can have tax nexus based on the activities of its employees and representatives, as well as owning or leasing real or business property in a state. It also could have nexus with a state or locality based on its sales to customers in such jurisdiction.

Generally, the nexus requirement is a low bar for most state and local tax authorities. Any exceptions generally are applied narrowly by a state or local tax authority. Therefore, a foreign company could have a filing obligation with a state or locality even though the business wouldn’t consider its activities to be significant.

Sales tax compliance. Sales tax is a significant consideration for businesses engaged in the sale of goods or certain services. Each state has its own sales tax rates, exemptions, and rules. Businesses must have strong policies and procedures related to their sales and use tax compliance to accurately collect and report taxes.

A company’s sales tax compliance procedures help mitigate overpayment of tax and avoidance of penalties. And failure to accurately charge sales tax could affect a business’s relationship with its customers.

Indirect tax planning. Understanding state-specific indirect taxes, such as property tax and use tax, allows foreign businesses to plan and budget accordingly. By considering these taxes in their financial projections and investment decisions, a company can better assess the overall cost of doing business in a particular state and make informed investment choices.

Reputation and customer perception. Compliance with state tax reporting requirements demonstrates a commitment to ethical business practices and can enhance a foreign business’s reputation among customers, partners, and stakeholders. It showcases a willingness to contribute to the local economy and abide by the laws of the states in which they operate.

By navigating the complex legal, regulatory, and tax landscape, foreign business owners could position themselves for growth, profitability, and long-term success in a US business environment.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jeff Driesen is director at Moss Adams, and has provided consultation on various aspects of international tax since 2008.

Glenn Walsh is CPA and partner at Moss Adams. He assists clients with state and local tax matters, including tax implications related to restructuring, mergers, and acquisitions.