Whether U.S.-based companies are established internationally or venturing offshore for the first time, it is critical that they understand international tax rules and their impact on foreign business ventures.
Concepts such as double taxation, transfer pricing and contemporaneous documentation can make or break a company’s foreign operations.
Managing the double tax burden
U.S. tax law requires that U.S.-based companies be taxed on worldwide income. A foreign subsidiary’s income can be deferred from taxation until it is received as a dividend.
But there are anti-deferral rules for subsidiaries that tax some profit, even if no actual cash distributions are made. These rules apply when it is perceived that a company is trying to reduce its foreign or domestic income tax. Anti-deferral status can create a particular hardship on companies that require cash to pay their U.S. tax.
In addition to taxation in the United States, the profits of both foreign branches and subsidiaries are subject to income tax in their respective jurisdictions. Because of this double tax dynamic, U.S. authorities provide a foreign tax credit to either alleviate or eliminate the double taxation.
Although the tax credit is aimed at relieving double taxation, for many companies, it doesn’t. That’s because the calculation of foreign income is complex and involves, among other things, the allocation of expenses such as research and development, and stewardship.
Companies that are unversed in the vagaries of foreign tax law can unwittingly pay twice for their overseas earnings.
Transfer pricing and contemporaneous documentation
Along with double taxation on overall profits, multinationals are subject to taxation on transactions between their domestic and foreign subsidiaries. The IRS has specific guidelines that govern these transactions, called transfer pricing rules.
Naturally, tax authorities here and abroad want to ensure that fair market prices are charged to subsidiaries for both goods and services. Annual price study documentation is required to gauge a company’s pricing structure to subsidiaries and unrelated parties to ensure parity. Companies without transfer pricing documentation are subject to nondeductible penalties of up to 40 percent of the transfer pricing tax adjustment.
The United States has led the drive to require real-time — contemporaneous — transfer pricing documentation, and the rest of the world is following suit. A number of foreign authorities now require documentation modeled after that in the United States. And they, too, impose harsh penalties when documentation requirements aren’t met.
With the growth of international opportunities, it is crucial that companies be proactive and vigilant in the international tax arena. To continue to grow ventures overseas, companies need to understand the importance of double taxation, transfer pricing and contemporaneous documentation.
And they need to proactively manage international tax rules and procedures to stay ahead in the competitive world of international business.
Paul K. Marineau ([email protected]) is an executive with consultants Crowe Chizek and Company LLC. Reach him at (616) 752-4232.
