Strategies for Lowering American Taxes in Absence of a Tax Agreement
Foreign entrepreneurs and investors are drawn to the US market by factors such as transparent fiscal policies, a robust legal system, economic stability, and lack of currency restrictions. However, navigating the US tax system can be complex for foreign-owned entities selling online. This article explores key strategies to achieve tax-free repatriation of profits from a US subsidiary of a foreign company.
Tax-free Repatriation: The Key Strategies
- Exempt Surplus and Dividends: Canadian foreign affiliates operating in the US track after-tax active business income in an "exempt surplus" account. Dividends paid out of this exempt surplus to the foreign parent (e.g., Canadian shareholder) are typically deductible for Canadian tax purposes, allowing tax-free repatriation on that level. A similar approach may be available under other tax treaties that prevent double taxation of dividends.
- Interest Deductions to Increase Exempt Surplus: Increasing deductible interest expenses reduces US taxable income, thus increasing exempt surplus available for dividend distribution to the foreign parent without additional taxes.
- Avoidance of Branch Profits Tax: Operating through a US subsidiary rather than a branch may avoid the 30% branch profits tax or benefit from treaty reductions.
- Liquidation under Section 332: Liquidation of a US subsidiary into a foreign parent can qualify for tax-free treatment if all assets are distributed within one taxable year, providing a possible exit strategy that avoids immediate US taxation on repatriated assets.
- Foreign Tax Credits and Deduction Planning: Recent US tax reforms have improved the foreign tax credit limitations, allowing more foreign taxes paid to offset US taxable income on foreign-derived income such as GILTI or FDDEI, reducing overall US tax and facilitating tax-efficient repatriation.
- Meticulous Tax Pool Management: New rules limit apportionment of interest and R&D costs, increasing available deductions on foreign income and enhancing opportunities for tax-efficient repatriation.
Given evolving tax legislation, including changes under the "One Big Beautiful Bill" and international cooperation on OECD Pillar 2, careful consideration of the specific tax treaty, corporate structure, and timing are essential.
S-Corporation Advantages and Considerations
The article also delves into the advantages of S-corporations, reasonable compensation compliance, the Foreign Earned Income Exclusion integration, and strategic implementation considerations for maximizing tax efficiency in diverse situations. However, other business structures like partnerships or US "branches" of foreign parents offer less liability protection and are not discussed in detail due to their reduced liability protections.
Foreign investors should engage in thorough tax planning with advisors familiar with current US tax reforms, treaty provisions, and international tax developments to optimize repatriation strategies. Delaware is often the recommended state to set up a US-based entity to minimize tax burden, especially for software businesses without a major physical presence.
However, it's important to note that the US consumer base can yield significant profits, but it also brings an array of federal income tax issues. A foreign investor may want to ensure privacy, asset protection, and tax minimization when investing in the US. The article does not cover the US taxation of foreign-owned LLCs or US companies and US bank accounts for foreign and domestic clients, which will be addressed in future posts.
- Engaging in thorough tax planning with advisors familiar with current US tax reforms, treaty provisions, and international tax developments can help foreign investors optimize repatriation strategies, as demonstrated by the strategies for tax-free repatriation of profits from a US subsidiary of a foreign company.
- To minimize tax burden when investing in the US, it's recommendable to consider setting up a US-based entity in Delaware, particularly for software businesses without a major physical presence, as this business structure often offers legal services and financial advantages.
