While I plan to eventually delve into more specific cases and scenarios that I am experiencing in my practice, I want to hold off on that for the next few posts in order to look at the topic of tax advising on cross-border transactions and businesses from a bird's eye view. Thus, for this post I want to speak more generally about some of the common pitfalls and challenges which are introduced when a company enters the U.S. market from a foreign country or vice versa. My discussion will highlight the fact that most of the issues imposed on such companies by the Code have fairly reasonable and intuitive rules. An important step towards mastering the rules and especially being able to speak generally about the rules with clients is understanding the goals which motivate each rule and developing your intuition until you can frequently guess what the tax treatment is likely to be under the Code.
So let's lay some basic groundwork about the international tax system before getting into specific rules. I should clarify the previous sentence; when I say "international tax system", I am referring to the U.S. system for taxing international transactions. The U.S. has a very elaborate system in place (and is probably the most aggressive country in this regard) of taxing cross-border and even foreign transactions where it believes it is entitled to tax.
It is worth highlighting that the goal of the U.S. tax system is ultimately to collect taxes. There are many specific rules which attempt to make the collection of such taxes either more "fair" or are an attempt to engineer certain non-tax outcomes. But ultimately the tax system is an extremely important source of revenue for the U.S. government and the rules reflect this priority of the tax system.
Taxing foreigners is hard. The basic problem of taxing foreigners is that, unlike U.S. persons, foreigners are harder for U.S. authorities to reach. This challenge for the U.S. tax system comes down to the fact that, when all is said and done, a judge cannot simply send a marshal to a delinquent's house and bang on their door to get them to pay up. Nor is this person likely to have assets in the judge's jurisdiction (i.e., the United States) that a marshal can seize. This sort of concern is what led to the system of withholding put in place by the U.S. for types of income that might be received by someone who will never be heard from again. Instead of waiting for the recipient to acknowledge their obligation to pay taxes on income sourced in the United States (what income is sourced in the U.S. is a separate and involved question), IRC Section 871(a) imposes a gross tax of 30% (by default, but frequently reduced by treaty) on primarily passive types of income such as interest, dividends, royalties, rents and others. Furthermore, IRC Section 1441 creates joint and several liability for "withholding agents" who are obligated to withhold and remit the tax liability created by this regime and insures compliance with the tax. The income taxed under these rules is commonly referred to as FDAP income (Fixed, determinable, annual and periodical income; this essentially means passive income such as what I listed above)
Thus, if you are a foreign person interested in opening a business or otherwise earning money in the U.S., you need to consider the impact of the withholding regime on your bottom line and plan accordingly. You can start to consider the relative merits of many types of tax planning depending on your needs and expectations. For example, you can create a U.S. domestic corporation to receive the income and keep it in the U.S. This at least delays the imposition of withholding tax. Or you can structure your contracts to have your business provide certain services or goods which have preferential treatment based on rights derived through mutual tax treaties between the U.S. and your country of residency. But one thing is certain; you do not want to simply ignore the possibility of 30% gross withholding on your income from the U.S., which is likely far higher than the tax you will be required to pay in your country of residence and may therefore result in more tax credits than you can utilize locally.
There are other ways that the U.S. can tax you as a foreigner. Keeping in mind the consideration above about the difficulty of reaching foreign recipients of U.S. income, what if you are a foreigner that has a more permanent presence in the U.S.? The withholding regime mentioned above is rather draconian in that it doesn't give you any benefit for the expenses you incurred in earning the income, something most tax systems will generally try to do. Most businesses would prefer to net their revenues against their expenses and pay tax on the net (even if the rate is higher at 35%, the effective tax rate is still lower). So the U.S. rule under IRC Section 871(b) (for individuals) and 882 (for corporations) is to tax this income like any other business income in the U.S. Why is this situation different from the way they tax (mostly) passive income mentioned above? Because the presence of a trade or business operating in the U.S. gives enough assurance that you have a continuous presence in the U.S. that the IRS can go after if you don't pay your taxes and take the income outside of the country.
What I have discussed above is just the tip of the iceberg and there are many other specific regimes used by the U.S. to tackle the challenges outlined above (and other challenges related to cross-border transactions). To a practitioner, it feels like an endless list of specific and seemingly unique considerations which come into play depending on the facts of a case. But as you, a tax practitioner or other party involved in tax, start to encounter these specific rules and regimes, you will develop a feel for when a transaction 'feels' like the U.S. will want to tax it in a special or specific way and when other more 'default' rules might apply.
No comments:
Post a Comment