International Tax Considerations for United States Businesses Operating Overseas

U.S. companies venturing into global markets or expanding their international footprint face a challenging and intricate web of international tax regulations. This article explores key tax considerations essential for U.S. business leaders to understand, both in the planning stages and during overseas operations. Proactive planning while taking into consideration a myriad of U.S. and foreign tax laws and regulations is paramount in effectively creating a comprehensive tax strategy. 

Regardless of where you operate, every U.S. company is subject to Federal taxation on its worldwide income. This means that whether your business sells products in Paris or Portland, receives interest or royalties from a foreign subsidiary, or earns income from services performed abroad, that income must be reported on the U.S. Company’s federal income tax return. That said, certain income, such as dividends received from a foreign subsidiary is not subject to U.S taxation. To complicate matters further, the country in which you are operating will also impose taxes based on your income, and thus a critical scenario: international double taxation. 

If a U.S. business entity is also subject to taxation in another country – let’s say France – then the same profit might be taxed twice: once in France and a second time in the U.S. which can lead to double taxation. If not planned for properly in advance, multiple jurisdictions can levy taxes, potentially resulting in a very high effective tax rate, much greater than the U.S. tax rate. 

Double taxation can be a significant drain on a company’s profits and is often a central concern for U.S. companies doing business abroad. Thankfully, the U.S. income tax system offers two options to mitigate being taxed twice on the same income —a deduction for the foreign income taxes paid or accrued, based on the U.S. company’s method of accounting, or a foreign tax credit which may be subject to certain limitations. The credit creates a much more favorable tax position on the surface, but foreign tax credits are subject to myriad rules and a detailed categorization system where income must be assigned among nine “baskets” for income type. Understanding these choices and limitations is key for each business operating outside the United States. 

Let’s say a U.S. company incurs a $20 tax in France; it can choose to take a tax deduction for the $20 against its taxable income or it can claim a $20 credit against its U.S. tax obligation. It is generally better to take a credit for foreign taxes than to deduct them because a credit reduces your actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax. That said, the foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on income from U.S. sources. However, if you choose to take the foreign tax credit, any foreign tax that exceeds your current year limit can be carried backward or forward, subject to certain rules.  

In addition to the tax legislation of each country, the International Tax Treaties that are in place between two countries play a pivotal role in creating advantageous tax strategies and reducing your effective tax rate. As part of your strategy in choosing where you expand globally, you will need to take into consideration the local tax rules in that jurisdiction and any applicable tax treaties. Originally developed to minimize tax burdens and promote global business, these tax treaties can be invaluable to U.S. businesses with an overseas presence. 

One key provision covered in many tax treaties is the Permanent Establishment (PE) provision. Many countries determine whether you are subject to taxation by whether your business is considered a PE. By adhering to specific activities and limits set forth in the treaty, a company can avoid creating a PE in the foreign country, thus potentially avoiding foreign taxation on the income earned in the foreign country. Understanding the conditions laid out in the tax treaty will help you plan how to operate your business to take advantage of any tax benefits to not having a PE. 

International tax treaties will also address how withholding tax may be reduced or eliminated on certain cross-border payments. Many tax treaties regulate the amount of tax that can be withheld from dividends, interest, and royalties paid by a resident of one country to a resident of another country. For example, if your foreign subsidiary is licensing the right to use intellectual property developed in the U.S. in a foreign country in which the U.S. has an income tax treaty, a reduced foreign withholding tax may be levied by the foreign jurisdiction due to a favorable royalty provision in the tax treaty. 

Most income tax treaties with the U.S. contain an article regarding royalties, providing a more advantageous tax rate that can be leverageable. Understanding these limits for each country you are operating in and the type of income that will be affected is part of an overall international tax strategy. 

Employees who work for you outside the U.S. may also be subject to taxation in the country in which they provide the service. In addition, oftentimes the activities of the employee will determine whether the company does or does not have a PE in the foreign country. However, with sufficient advanced planning, you can often structure the affairs of the employee to take advantage of favorable provisions offered by an applicable income tax treaty. Understanding the tax landscape in each country where you have employees is important to supporting your employees and mitigating the foreign tax impact on the company. 

Every company needs to keep pace with changes in international tax regulations. The Tax Cuts and Jobs Act (TCJA) introduced in 2017 brought about significant alterations in how the U.S. taxes income earned overseas, transitioning from a global to a territorial tax system. This change removed the additional tax on profits made outside the U.S., encouraging businesses to transfer domestic earnings to subsidiaries in countries with lower taxes to reduce their global tax obligations.

To combat the risks of tax base erosion and the shifting of profits to avoid taxes, the TCJA implemented new measures against tax avoidance, including the Global Intangible Low-Taxed Income (GILTI) provision. GILTI imposes a minimum tax on overseas profits derived from intangible assets like copyrights, patents, and trademarks, reflecting the shift to a territorial system. This move altered the dynamics of tax avoidance and the management of Intellectual Property (IP), applying a systematic method to tax earnings exceeding a 10% return on tangible assets, regardless of whether these earnings are from intangible sources.

Simultaneously, the Organization for Economic Cooperation and Development (OECD) is advancing a comprehensive approach to address Base Erosion and Profit Shifting (BEPS). BEPS involves strategies by multinational companies that exploit tax rule discrepancies to minimize tax liabilities, significantly impacting countries that depend heavily on corporate tax revenues. Through the OECD/G20 Inclusive Framework on BEPS, over 140 countries are joining forces to implement 15 actions aimed at curbing tax avoidance, enhancing the consistency of tax laws internationally, and promoting greater transparency in the tax system.

Understanding the impact of TCJA’s international provisions can help business owners approach their efforts to expand abroad while taking advantage of favorable tax policies.

For U.S. businesses with a global outlook, it’s crucial to understand the nuances of international taxation. Proper planning and adherence to tax rules and regulations can help companies minimize their worldwide tax burden and the tax burden of their employees who work abroad. It can help to work with a trusted international tax compliance expert to guide you through this complex process.