International entity structure planning

INTERNATIONAL ENTITY STRUCTURE PLANNING

If you do business internationally, the entity structure in both the U.S. and the foreign jurisdiction is one of the most important tax planning decisions you will make as it can significantly influence the total amount of income taxes that are ultimately paid. Many U.S. closely-held businesses utilize some form of a pass-through entity in their structure planning (an S corporation, LLC or partnership, where the income is taxed on the personal returns of the owners) as opposed to a C corporation (where the corporation reports and pays tax on its income).

The entity selected for your foreign activities must be compatible with the domestic parent in order to minimize the overall tax burden. Compatibility is influenced by many factors, including:

• Ability to claim a credit against your U.S. tax liability for foreign taxes paid
• Timing of taxation of profits; current taxation versus deferred until repatriation of profits
• Availability of losses of foreign operations against domestic income

The Internal Revenue Service has proscribed regulations that allow the domestic company to elect the tax treatment accorded to the domestic taxation of the foreign entity. Under these regulations, foreign corporations can be treated as:

• A branch, if wholly owned
• A partnership when more than a single owner is involved

Treating a foreign corporation as a flow-through entity for U.S. tax purposes is done via an election (known as the "check-the-box" election and made on Form 8832) and is made strictly for U.S. tax purposes. The foreign entity retains its corporate identity in the foreign jurisdiction. Similarly, foreign branches and unincorporated partnerships can be treated as corporations for U.S. tax purposes via the same election process. This election giving the same entity corporate characteristics in one jurisdiction and non-corporate characteristics in the other creates what is known as a hybrid entity.

To the extent your foreign subsidiary operates in a low-tax jurisdiction, it may be able to enjoy deferred U.S. taxes. Concerned that U.S. corporate taxpayers would take advantage of this deferral technique, Congress enacted Subpart F of the Code to discourage U.S. taxpayers from using foreign corporations to defer U.S. taxes by accumulating certain types of income in foreign base companies located in low tax jurisdictions. Active business operations conducted by foreign corporations are not generally affected by these provisions.

If a tax treaty between the U.S. and the country where you are doing business, part or all of your items of your income may be eligible for a reduced rate of tax or withholding on the income at the time the monies are repatriated to the U.S. Effectively utilizing the benefits of a treaty when it does exist can significantly reduce the amount of total tax that is paid on your business income.

Losses of foreign operations can be passed through to owners of closely held businesses with fewer obstacles than for widely held companies. Multi-tier hybrid structures can provide S corporation, LLC, or partnership owners with access to the losses incurred in their foreign affiliates. Often, the passive activity loss limitation rules will not apply to non-active owners due to income of the U.S. operations. For actively involved owners, various arguments are available to support the contention that the foreign activities are not passive activities. Further, hybrid entities enable the U.S. owners to get current U.S. benefits while preserving loss carry-forwards locally.