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US Market Entry By
Foreign Companies INTRODUCTION Successful entry into the US market comprises many aspects. Accounting, administration and taxation are important elements, some of which have to be considered whether one enters by solely exporting from a foreign country or establishing a US base. Hopefully, the following will touch on the intricacies and help the reader consider some of the parameters prior to engaging professional assistance and then how to utilize such advice and consultation. TAXATION The US has Federal, State and City taxes. Let me note that taxation, like many legal and other aspects, is dramatically more complicated than perceived by foreigners or indeed the average American. To provide an idea of the complexity, in our office we carry copies of all official Federal, State and City tax forms and that alone amounts to over 13,000 forms. The pages are too many to count, but certainly comprise several thousand pages! Then we have copies of the federal tax laws, court cases, regulations and rulings and just to be "helpful" the IRS issues publications dealing with various topics and instructions for completing their forms. Perhaps, just to add to the fun, it is the substance over form that counts. So that in drafting contracts you can not just examine the law. Even worse, you can not just read the law because it must be interpreted after taking into account the intention of the formulators (the house and senate tax committees) and other factors. Federal tax rates are:
Of course, the taxes are based on profits calculated in accordance with the tax laws, not book profits. Adjustments to book profits There are many adjustments which are required by the tax laws, these include:
Related party transactions Transactions with foreign-related parties have to be reported to the Internal Revenue Service "IRS". They are mainly interested in the areas of transfer pricing, interest, management fees and royalties. The IRS has extreme powers to attack these areas and does so. One way of dealing with these items is to have them regulated by legal agreements between the foreign and US operations. Then, under audit by the IRS, the levels can be explained and justified. However, there are specific rules on transfer pricing, they require an economic pricing study to be undertaken, Essentially, the aim is to tax US subsidiaries on that proportion of world-wide group profit, that US sales bear to world-wide sales. For more information, see "The Chartered Minefield of US Corporate Tax". State and local taxation Remember, this "Country" comprises 50 totally independent countries loosely governed by the Federal Government. Think of what the tax laws would be like if Europe had 50 countries AND the EU made no effort to standardize such items as VAT. The taxes may sound the same from state to state, but assume the rates, rules and interpretations are very different. This complex area is often overlooked. Yet it may cause some of the greatest difficulties. Firstly, it is important to decide where the corporation and staff should be taxed. This is not so easy. It will depend on sales contracts` salespersons, employment contracts, premises and other factors. Most of the States have entered into a multi-state tax agreement. Essentially, this is an agreement between the states as to how they will allocate profits, when a company does business in more than one state. Essentially, the profits are allocated on the ratios that total sales, employees remuneration and value of assets in a particular state bear to the totals for the company. For a company, limited to one place of business, say in New York City, but incorporated in Delaware, it will have to file Federal, New York State and New York City tax returns and Delaware franchise taxes and if it is "doing business" in other states, then it will have to file there too. Do not forget that the legal and accounting costs will increase dramatically with the number of states that are involved. Also sales and use tax is complex. For example, a building contractor may have to pay sales tax depending on the location of the building. But, if the products are exempt from sales tax, then use tax may be payable on the cost of materials used in the construction. This may sound easy, but think of a contractor with operations in one city attempting to make installations in several locations and states. The analysis of purchases and sales becomes complex beyond belief. The taxes levied vary by state. Some have corporate taxes others have none. New York State Tax New York State tax is usually 7 1/2% of income with a minimum of between $100 and $1,500. The Metropolitan Transportation Business Tax Surcharge is an additional 17% of the New York State Tax. New York City tax is at a rate of 8.85% on net income with a minimum of $300.00. Note, that New York State / City has minimum taxes based on capital employed. Staff Foreign based staff undertaking work in the US should, if possible, be on the US payroll and paid from the USA. As you may know, if staff work in the US for more than 90 days or earn the equivalent of more than $3,000, they are required to file US tax returns. By having the staff on the US payroll, it isolates the foreign company from legal problems and deals with the US tax in an organized method. Staff working in the US are usually taxed in the US as residents if they are: US citizens, "green card" holders or have been in the USA for more than 183 days over a 3 year period using the weighted average formula. Royalties If the US company uses a trade name or other patented processes of the parent firm or of owners of the trademark who could be registered in other countries, it can pay for the use of these, but the ability to deduct such payments, for US tax purposes, will depend on tax regulations. In general terms, again, one should aim to do it as if it were a third party contractor. Interest The parent may charge interest for loans. Again, it should be on a reasonable basis, and one must be careful not to be "thinly" capitalized, as mentioned elsewhere. Individual taxation Like corporations, taxation is levied on individuals at the federal and local level. State and city taxes vary widely from place to place. Federal taxes go from 10% to 35%. In New York State the highest marginal rate of 6.85%. In New York City the highest marginal rate of 3.648%. Tax returns - the honesty system It is the responsibility of a business and individual to tell the government of the amount of tax due and then pay that tax. Essentially, during the year and at the time of filing tax returns, tax must voluntarily be paid to the relevant authority. Then, at the correct time, a tax return must be filed explaining the amount due, making an additional payment or requesting a refund. The authority then takes the money or pays a refund and files the return, in their computer system. How nice and simple. The only catch is how to keep honesty alive. This is done by a system of fines and penalties, both monetary and criminal. That is bad enough. But, in general terms one can not ask the authorities to "bless" a return. They will, in certain limited circumstances, agree the method of dealing with some unusual items, but this tends not to be useful for the average business. The result is a lack of certainty, especially for creative solutions. Another danger is the cost of legal defense should problems occur. Furthermore, the taxing authorities do not rely on accountants' reports. They use their own auditors and may inspect records on an annual basis. ACCOUNTING There are few requirements for the non-publicly held company to prepare financial statements. The IRS requires that proper books and records be kept and tax returns be completed. Tax returns have to be completed in accordance with US GAAP and modifies according tax rules, court cases and regulations. There is no requirement for non-publicly held companies to have audited statements. Indeed most do not. Frequently, banks will not require audits for loan clients due to the cost involved. In absence of an audit, a company may have compiled financial statements prepared by an accountant. Broadly speaking this means that the accountant has prepared them, but accepts absolutely no responsibility for them A slightly better version is a Review, this in broad terms means that the accountant has attempted to satisfy himself that the accounts conform to Generally Accepted Accounting Principles "GAAP", but the statements are still the representation of management and not examined by the accountant except very superficially . Generally Accepted Auditing Standards "GAAS" regulates how the accountant should undertake such assignments. What is GAAP and GAAS? In simplistic terms, it is the accountants' rule book. In recent years the pronouncements have become voluminous, complex and in some cases confusing. Also, be sure to understand the extent and type of work done by an accountant during an audit. To be slightly cynical, it may be that an audit and review concentrates more on form than substance. For the foreign investor, US GAAP may only be important for tax purposes, with comfort being provided by requesting the accountant to undertake mutually agreed upon work. Sometimes called a limited review. Seemingly, the detailed rule book should make the accountant less flexible than in other countries. In reality, there may be considerable room for horse trading - especially for the client who understands the rules! Let it never be said that a professional accountant considers audit risk (liability or fees) during the course of an engagement. For the publicly held business, the Securities and Exchange Commission "SEC" regulates the information that is required to be filed and those who may practice before the SEC. This is another maze for those who chose to be part of that system. LEGAL Legal matters are dealt with by attorneys, nevertheless, let me make some comments: Because of the litigious nature of this society, much more time is spent planning the avoidance of legal catastrophes than would be the case in Europe. This follows through into taxation and other matters such as royalties, management fees, licenses, appointment of personnel, etc. One of the important purposes is to isolate the home country operations from the US ones. The company should be "adequately capitalized" for two reasons:
What is "Adequate Capitalization". Well, somewhere probably between 25% to 30% of liabilities. As previously indicated, laws are promulgated by the Federal, State and Local governments. Although mainly derived from the English Common Law system, it has been dramatically altered. States reserve to themselves the right to make laws AND vigorously use that right. Providing they adhere to the "Constitution" the Federal Government has few sanctions, hence a veritable lattice of unbelievable rules has developed with little logical rationale between States. Many businesses in the US require licenses and this may be on a Federal, State or City
basis. Corporations A corporation will need a Board of Directors and Officers. The Board really undertakes the same function as Non-Executive Directors. Officers usually comprise a President, Treasurer, Vice-President and Secretary. The officers are the ones who run the day-to-day business. Once they are appointed, it is or can be difficult to deny that they have authority. For example, the top person is usually the President, practically it is difficult to restrict his decisions and actions relating to third parties. Companies are formed by Attorneys, not Accountants. Corporations and other legal entities are created by State laws. Hence Corporate Law varies widely within the USA.
CONCLUSION Most important of all, the point to emphasize is that the US has been a success story for some foreign owned businesses. On the occasions when they are successful, what a market! I believe that the present economic climate in the USA has the potential for change. The foreign investor and trade should consider how their plans and operations will fare under differing scenarios. Will: The trade deficit (continuous imports), strength of the US dollar, low interest rates, high government expenditure (not only defense and welfare), high "overall" taxation and large service industry, be beneficial or impact the foreign investors' aspirations? Perhaps, the tax system may give an inkling of some of the pitfalls and opportunities. This can be especially important to the foreign owned business. All entrants should carefully look at their marketing, sales, management, operation and other plans and then use a "devil's advocate" to shoot them down. Still many business people feel that this is not necessary! Once in operation, it is probably management of the US operation that is the most fraught with difficulties and needs careful planning. Be sure to do your home work and understand your advisors (and their goals). A profitable welcome to the world's second largest group of markets. CHECKLIST The following checklist may be useful in considering operations in the USA: Professional advisors:
Operations:
Staff:
Equipment required in the US:
Banking:
Capital contributions:
Financing:
Taxation:
Accounting:
Insurance:
Management:
Marketing:
Sales:
Budgeting:
Patents, trademarks and know-how:
Shareholders and operating agreements:
Customs duty:
Federal, State and / or Local Licensing:
No information contained herein shall be taken as a professional opinion. In this page or website or any attachments thereto any comments are not to be taken as professional advice. The writings are not intended, and cannot be used by you, to avoid any penalties the Service (or other tax authorities) may impose as a result of taking any position in this writing. Angus McDowell, McDowell CPA PC |