- Apr 1, 2022
Doing business globally can include having a subsidiary, office, investment or simply a bank account located in a foreign country—all of which require appropriate disclosure to the IRS. In this video, we’ll examine why reporting on foreign operations for tax purposes is an important matter for technology and life sciences start-ups doing business abroad.
Matthew Halpern:My name is Matthew Halpern. I specialize in cross-border transactions and multinational entity structures.
Reporting on foreign operations for tax purposes is an important matter for many of my technology and life sciences clients. I always like to start off a conversation with my clients by gaining a better understanding of their operations, organizational structure and customer locations. Often times, I find my clients have already been doing business on a global scale. Perhaps their global operations are small, maybe a few online orders or shipments, but other times they are fully operational, already servicing customers with foreign offices and employees. Many of these foreign operations are simply cheaper cost centers and back offices.
Since the U.S. taxes its citizens, residents and entities on a global scale, the IRS requires an abundance of disclosure. Whether you have a subsidiary, office, investment or simply a bank account located in a foreign country, there is some form of disclosure and by no means are they simple.
For instance, investing in a foreign partnership does not necessarily mean that entity is treated as such, domestically. There are various default rules which create hybrid entities. A hybrid entity is one where the U.S. tax classification is different from its local classification. This may create what are called controlled foreign corporations, or (“CFCs”). CFCs are taxed differently from a U.S. corporation. Often times there are income inclusions to the shareholders without the physical repatriation of cash. The tax effects vary depending on the type of shareholder as well as the overall structure and operations of the organization. The U.S. does allow a variety of elections that can be made to treat the foreign entities as partnerships or disregarded entities to better align the original intention of the taxpayer’s structure of operations.
Often times, I see a U.S. technology company opening a back office in India or some other European country which has low costs when compared to the U.S. This foreign entity generally defaults to a corporation from a U.S. tax perspective and automatically falls subject to the CFC tax regime. This can essentially tax the profits of its back office, again in the U.S.
Another situation occurs when a client has operations in a foreign jurisdiction but without creating a legal entity. This often creates what’s called a branch or a permanent establishment. These operations are generally taxed by the local authorities and then combined from a tax perspective with the U.S. operations.
These examples can create an effect where the same income is taxed in multiple jurisdictions. Luckily, the U.S. allows a foreign tax credit which can offset some of this double taxation effect, however there are many rules and restrictions regarding claiming the credit.
Some of my life sciences clients, for example, want to take advantage of another country’s favorable research and development credits, such as Australia. Instead of creating a legal entity in Australia, they may just open up an R&D department & office. By hiring local employees to work out of this office, generally creates a branch/permanent Establishment which may be taxable as a separate entity from an Australian perspective.
Transcribed by Rev.com
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