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US Taxation For
Foreigners It is often assumed that America is a country with no regulations. In reality, it is probably the country with the most regulations. For example there are over 13,000 different tax forms in the USA. Understanding US taxation, is a subject for the experts, here we can only note some significant matters which affect foreigners doing business in the USA. US ENTITIES OWNED BY FOREIGNERS - TAXABLE ON WORLD-WIDE INCOME In most cases US entities are taxed on world-wide income and they are required to file all necessary Federal Income tax returns. For example a Delaware LLC, LLP or partnership have to file Federal Income Tax returns and in any other American States where they are doing business and are required to file returns. The "partners" have to pay Federal, State and Local taxes as appropriate. The one exception to the payment of tax, may be when all the "partners" are not required to file tax returns in the USA and all the income is non-US source income. However, in most cases, this exception does not apply to the filing of tax returns or keeping proper books and records. BRANCHES IN THE USA - SOME FACTORS RELATING TO THEIR BECOMING SUBJECT TO US TAXATION To be excluded from taxation operations in the USA must either be exempt under US tax law or by operation of a double tax treaty. Even if exempt under a double tax treaty, the entity should usually file a tax return, specifically claiming exemption under the treaty. IS A BRANCH EXEMPT FROM TAX UNDER A DOUBLE TAX TREATY? The treaties specify certain conditions under which foreign businesses are exempt from taxation in the USA, additionally other conditions may be varied. Most of exemptions are strictly enforced in favor of the taxing authorities. In certain cases, the US chooses to ignore provisions of the treaty. The tax treaties usually only apply to Federal Taxation, not States or Localities. For example treaties may include the following relating to operations of foreign businesses in the USA. Often operations will be specifically subject to US Federal taxation if they have a "permanent establishment" in the USA. The term "permanent establishment" usually includes a fixed place of business in which the business of the enterprise is wholly or partly carried on, including a place of management, a branch and an office. Often operations may be exempt from US Federal taxation so long as they do not have a "permanent establishment" in the USA. The term "permanent establishment" includes:
TAXATION OF FOREIGN OWNED BUSINESS Some years ago, the US Government decided that it would attempt to collect tax from foreign owned businesses which the government felt were not paying their fair share of US tax. To assist in this objective they setup a special unit of the Internal Revenue Service "IRS" to audit foreign businesses and also enacted laws aimed at collection of more taxes. These laws included the strengthening of regulations relating to "Transfer Pricing" of goods and services, requiring economic studies of the product and world-wide profits of the group companies. The rules even for small foreign owned companies are harsh. TAXATION OF FOREIGNERS WITH US (BRANCHES) ACTIVITIES OR INCOME Although the United States generally taxes U.S. persons on their worldwide incomes, it asserts only a limited taxing jurisdiction over nonresident alien individuals and foreign corporations. Foreign persons pay U.S. taxes only on income that has a sufficient nexus with the United States. Congress overhauled the basic rules on the taxation of foreign persons in 1966. In 1980, Congress added rules to tax foreign persons on virtually all sales of U.S. real property. In 1986, Congress added the branch profits tax to impose a second level of tax on a foreign corporation that engages in a U.S. business and then withdraws the earnings from the U.S. business. The United States uses two quite different regimes to tax the income of foreign persons. One regime imposes a 30 percent tax on the gross amount of U.S.-source income of specified types not effectively connected with a U.S. business. The second regime applies regular U.S. tax rates to the net income effectively connected with a U.S. trade or business (or treated as so connected). A taxpayer with both types of income may be subject to both tax regimes in a single taxable year. Certain gross income not from U.S. business. A nonresident alien individual or foreign corporation pays a flat 30 percent tax on income that (1) arises from a U.S. source; (2) falls within the term "fixed or determinable annual or periodical gains, profits, and income" or within certain other categories listed in the statute; and (3) is not effectively connected with the conduct of a U.S. trade or business. A U.S. treaty, however, may reduce the 30 percent rate or exempt an item from tax altogether. IF A FOREIGN ENTITY IS TAXABLE IN THE USA, WHAT IS THE BASIS FOR TAXATION? Foreign owned branches and entities are taxable at usual US corporate income tax rates based on US tax laws. Additionally, there is a branch profits tax, which is essentially the deemed dividend payable on profits transferred to the Head Office. This would be subject to reduction by a Double Tax Treaty. Perhaps the major item subject to recalculation in determining a foreign owned entity or branch's profits is the cost of goods purchased. The purchases are subject to the Transfer Pricing Regulations and Code Section 482 of the Internal Revenue code. TRANSFER PRICING A domestic entity often sells products to or buys from a controlling foreign entity. A transfer price that is too low for an outbound sale (or too high for an inbound sale) may result in an understatement of U.S. taxes. For more information see The Chartered Minefield of US Company Tax Either the Service or a taxpayer may use "unspecified methods". One of such methods may be referred to as a "sixth method". The Service and the taxpayer must apply the best method rule to decide which method to use. Under certain narrow conditions, the comparable uncontrolled price method is the most accurate. The regulations are worded in terms of an arm's length amount for a transfer subject to Section 482. However, the regulations allow the Service to group products or to use statistical sampling methods. By their terms, the regulations apply to "controlled transfers" of tangible property. Such "transfers" should include a sale or an exchange. The regulations under Section 482 generally deal separately with transfers of tangible and intangible property. In many cases, however, both types of property are involved. The regulations deal expressly with overlaps. If a company is taxable in the USA, one may want to enter into discussions with the IRS to achieve an agreement on the basis of calculating transfer prices. 1. RECORD KEEPING If the company is taxable in the USA, it must keep certain records relating to transfer pricing. PENALTIES Penalties can be imposed for a substantial or gross valuation misstatement of transfer pricing, Section 6662(e), is applicable to taxable years beginning after December 31, 1993. The provisions became effective September 1, 1995. Section 6662(e) generally provides a penalty equal to 20 percent of the underpayment of tax attributable to a substantial valuation misstatement. The penalty is increased to 40 percent of the underpayment of tax attributable to a gross valuation misstatement. A substantial valuation misstatement exists if either:
3. ADVANCE PRICING AGREEMENTS The Service established the advance pricing agreement (APA) program to supplement the traditional administrative, judicial, and treaty mechanisms for resolving intercompany pricing issues. The APA program has, to date, been represented as an efficient resolution to the problems faced by the Service and taxpayers when dealing with issues under Section 482 with the goal to help taxpayers, the Service, and treaty partners avoid the lengthy and expensive disputes that often arise from proposed transfer pricing adjustments. The process also requires taxpayers to voluntarily disclose extensive information about their operations and methods, educate the Service about their businesses, and prepare detailed analyses of their companies, markets, and competition. Traditionally, this information has not been made available to Service agents prior to the audit and, then, only if requested. In this regard, the Service has allowed taxpayers to limit the discussion, frame the issues, and restrict their disclosures to those necessary to understand and resolve the transfer pricing and related issues brought before the Service. STATES AND TAXATION OF FOREIGN BUSINESSES IN THE USA Generally States in he USA have a right to tax activity in their State, that is the Federal Government can not regulate what the States do, neither can the Federal Government enter into Tax Treaties with other countries with affect the States. For example, New York State specifically requires that income exempted under a double tax treaty is taxable in New York State. New York State has its own definitions for doing business in New York State and when "Foreign" (this includes foreign countries and States within the USA, other than New York State) are taxable in New York State. Because many American businesses operate in several States, some States have come to an agreement between themselves as to how those States will allocate such income between themselves. This may impact the taxation of non-US businesses doing business in the USA. Any income tax payable to a State will be deductible for Federal Tax purposes. LOCAL OR "CITY" TAXES AND TAXATION OF FOREIGN BUSINESSES IN THE USA Local income taxes are generally restricted to some of the larger "cities". They may have different rules from Federal or the relevant State. For example in New York City: Generally, a corporation must file New York City tax returns if they are:
Even if the corporation is exempt from New York City tax, it must annually file form NYC-245. The sub-renting of a office would be taxable in New York and would constitute doing business in New York. Additionally, businesses may have to file forms such as New York City Rent Tax. Any tax payable to New York City will be deductible for Federal and New York State Tax purposes. HOW CAN WE HELP? We advise on how to structure foreign businesses entering the US markets and with your ongoing needs once you have US tax filing obligations . Our advice starts before you even take your first business step in the USA. Foreigners have to consider which foreign jurisdiction is the best through which to hold US businesses. It is not only the business aspects which are important, for wealthy individuals, the planning may have to start 2 years or more prior to commencing operation or moving executives to the USA. This includes the best State to incorporate your business, advising on specific State and Federal tax issues and preparing the various tax and informational returns. Because we have lived and worked inside and outside the USA, we understand the difficulties (from a tax aspect) foreign companies have on entering the US market. This includes those who have incorporated Delaware companies without having operations in the USA. See "The USA as a Tax Haven". The USA is a big market with large potential profits, now make sure you do it properly! If you are already operating in the USA, contact us for a review of your current tax position. E-mail us for a quotation. We will need a broad details of your plans or current situation for example:
If you just need guidance, assistance or technical advice with a specific issue, we can help you via e-mail. |