How to limit tax risk when expanding to U.S. market
By AdvocateDaily.com Staff
Small and medium-sized businesses considering expansion into the U.S. need to plan ahead to ensure they have limited tax exposure, Oakville-based U.S. tax attorney Alexey Manasuev tells AdvocateDaily.com.
“Expanding into the U.S. can be a very successful enterprise that gives small companies access to a much larger market,” says Manasuev, principal of U.S. Tax IQ, an Oakville-based American tax consulting services firm.
But, he adds, in addition to having the right products, services and market conditions, it’s critical to have a solid understanding of taxation rules south of the border.
The wrong approach could be costly, Manasuev warns.
“The landscape in terms of enforcement and compliance of cross-border taxes — and U.S. taxes in particular — is complex," he says. "There is much more transparency between tax authorities around the world and they share information with the U.S. Internal Revenue Service (IRS). You want to make sure you’re complying with the rules and not subjecting your business to double taxation and unnecessary and hefty penalties.”
GET THE RIGHT HELP
The key starting point is to talk to a knowledgeable and experienced professional about the U.S. tax system, particularly, about international and cross-border taxation, Manasuev says.
“In the U.S., as a business, you still have to file tax returns, even in the absence of profits,” he says. “You want to make a small investment by talking to a qualified U.S. tax advisor to ensure you’re getting good advice. By using a U.S,-qualified tax advisor, a business can protect itself from penalties if the IRS challenges the tax position it has taken on its tax return."
STRUCTURING THE EXPANSION
You shouldn’t just expand, without proper structuring, Manasuev explains.
"In structuring the expansion strategy, it’s important to consider the objectives of the business, he says. For instance, incorporating a subsidiary may not be the best strategy for a business with low revenues and limited U.S. business activities.
Beware of entity forms that may present tax problems: one possibility is a limited liability company (LLC), Manasuev says.
“There are important considerations about LLCs so businesses should be careful about how and when they’re set up because that could impact taxation,” he says.
Making an investment through a partnership is another option. Manasuev says in this scenario, businesses must be mindful of where the majority of their investors are located.
“If all the investors are U.S. citizens, they might be able to set up an S corporation that provides certain benefits for small business owners,” he says.
In some situations, it might be best to carry on business independently and remain self-employed, Manasuev says, noting that the business-specific goals are critical to determining a plan.
“You can’t simply look at what you’re planning on doing today or tomorrow, you should think about your exit strategy,” he says.
If the goal is to sell the investment, the U.S. operation should be structured in a way to achieve the best possible tax result. If the plan is to be in business for a long time and pass it on, a succession plan is necessary.
“Once you get the proper advice on how to structure your investment, you need to make sure that it allows you to effectively manage applicable U.S. tax exposure,” Manasuev says.
Transfer pricing is one of the key areas that should be addressed. That involves examining the functions of the company, risks assumed, and the resources employed to ensure the entities are properly characterized and that an appropriate transfer pricing methodology is in place.
“You need to manage your tax exposure, which is not simply setting up the structure and running with it, but also looking into planning opportunities and taking advantage of those,” he says.
TAX EXPOSURE AND BENEFITS
When investing in the U.S., businesses need to consider several layers of taxation: U.S. federal, state and local, and the applicable U.S. tax treaty, so you need to ensure that you address all of them and manage them on an ongoing basis, Manasuev says.
A big part of tax risk management is ensuring that the business qualifies for treaty benefits, he adds.
“Generally, repatriating income from the U.S. subsidiary to a Canadian company would attract 30 per cent withholding tax, but that can be reduced to five per cent under certain circumstances,” he says. However, the business must qualify for treaty benefits to qualify for a reduced withholding tax rate.
EMPLOYMENT TAXES AND IMMIGRATION CONSIDERATIONS
Effectively managing tax exposure means the company needs to take care of employment, income tax and payroll liabilities in addition to obligations, Manasuev explains.
“A Canadian company with a U.S. subsidiary that sends employees back and forth is required to issue certain forms to the employees who, in turn, must file quarterly. The company is also obligated to withhold employment taxes on behalf of the employee. If the company fails to ensure the forms are properly filed, it can be liable,” he says.
Manasuev says in addition, you need to make sure that employees or executives are authorized to do business in the U.S. They may require a work visa.