Can You Be Caught Between Two Tax Authorities When Operating In The US And Abroad?
Four Ways to Minimize the Risk: The unprecedented onslaught on tax havens in recent years combined with the adverse publicity given to some large multinationals for paying “obscenely low” levels of tax has had a serious result – tax authorities worldwide are under pressure to plug tax loopholes and raise more tax revenues from corporations. If your company has foreign operations, it is especially important that you navigate a path that does not catch your organization between tax authorities at your home country and abroad.
Here are four ways in which you can minimize this risk:
- OECD Digital Tax
The Organization for Economic Co-operation and Development (OECD) and its Task Force on the Digital Economy (TFDE) has published plans to shake up the global tax system by introducing a unilateral approach to the taxation of digital services. Their proposals if implemented by the G20 will over time significantly impact online marketplaces and social media platforms. The OECD proposals have attracted widespread criticism from both digital and non-digital multinationals for both singling out the highly digitized tech industry and for suggesting that “fair” taxes should be levied in situations where there is no corresponding increase in value or actual profit. There is also a concern that the OECD may seek to propose the concept of a turnover tax regardless of actual realized profit.
These are currently only proposals that need to be approved by G20 and then translated into local country law, but if approved, could result in unavoidable double taxation. Also, of concern is the introduction of unilateral measures in countries such as Australia, India, UK, Italy and France complicating the taxation environment for multi-nationals.
- Tax Planning & Transfer Price Benchmarking
The US has tax treaties in force with 68 countries. However, the list does not include key markets such as Brazil, Singapore, Taiwan and Hong Kong. A tax treaty being in place is useful in legally avoiding double taxation. The lack of a tax treaty can sometimes be accommodated by setting up a branch in the target country (e.g. US to Taiwan) or by setting up a foreign holding company in a country (e.g. Netherlands) that does have a tax treaty with the target country. However, care needs to be taken because shell holding companies with no substance are vulnerable to attack by tax authorities.
Another important direct taxation aspect is the need to ensure that the transfer price charged by US to its foreign subsidiary is an “arm’s length” price, i.e. is a price that would have been charged had the foreign subsidiary been a genuinely independently owned company. It is critical to be able to justify the transfer price to avoid being squeezed between the IRS and the target country tax authority. Adding to the complexity, tax authorities worldwide use different databases for establishing the arm’s length price (e.g. India’s ITD uses databases different to IRS).
However, all is not lost if there is a disagreement between IRS and HMRC (the tax authority in UK) as to what the right tax is to have paid. They have an agreement as to how to divide up the “tax cake” between them and will just let you know!
Obtaining expert tax planning help and regularly re-evaluating the tax structure as the business changes its priorities and scope is one key to avoiding multi-country tax pitfalls.
- Pass-thru Entitles
If you are a smaller multinational company with lower headcount operations abroad, the IRS offers a break which is unique to the US. This is called a “Check the Box” (CTB) Election. By electing CTB, the IRS will treat the foreign subsidiary as a pass-thru entity. Therefore, even if US does not have a tax treaty with the target country, the CTB rules can be used to enable a tax credit to be claimed in US for corporate taxes paid in the target country.
However, there is a note of caution – CTB only applies to certain types of limited liability foreign entities listed by IRS.
- Indirect taxes
Indirect taxes are another pitfall for the unwary. Often the attack focuses on exploiting contradictions between the allowable activities of the foreign subsidiary as recorded in its constitution documents, the job titles and job descriptions of the personnel it employs, and the description of the activities being carried out as set out in the US/local country intercompany agreement. The aim of this process is to justify levying indirect taxes on the intercompany invoice which the US then cannot recover – a potentially huge irrecoverable cost!
There are opportunities and challenges in doing international business. One challenge discussed here is how to avoid being squeezed between IRS and a foreign tax authority. This can be avoided by tax planning but it requires a multi-disciplinary approach and knowledge of the constantly changing business landscape.
Ensuring consistency between the tax plan, entity setup documents, HR documents and the US/local country intercompany agreement is crucial to avoiding these types of pitfalls. Obtaining expert tax planning help and regularly re-evaluating the tax structure as the business changes its priorities and scope is one key way to avoid multi-country tax pitfalls.
Written by Dr. Shan Nair.
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