Tax aspects of global expansion.

The form of the business should be a major factor.

Companies wishing to do business worldwide must analyze the many tax issues involved in going global. A key one--which has to be decided first--is the form of the organization that will conduct the business. General economic factors, such as risk management or market penetration, often are the primary criteria a company's decision makers factor into their analysis. However, because different organizational structures involve different tax consequences, a company should consider tax effects as part of the analysis. Central to this analysis is the foreign tax credit (FTC), which comes into play regardless of the form chosen.

In general, the IRC taxes domestic corporations on their worldwide income, regardless of where they earn it. So that income is not taxed twice, a company is allowed to claim an FTC for income taxes paid or accrued to foreign countries (up to the amount of the U.S. tax imposed on the foreign income). In effect, companies are allowed to credit foreign tax against the U.S. tax on the foreign income.

FORM OF OPERATIONS

Several possible organizational forms may be used for foreign businesses, depending on the type of business involved.

Exporting. An already existing domestic business can supply a foreign market through direct exports. Export sales generally do not result in foreign tax. If a company has an FTC available, income from export sales may be effectively taxed at only half of the normal U.S. rate. At the same time, U.S. companies without excess FTCs may be able to set up foreign sales corporations (also known as FSCs) to reduce the taxes on export sales.

Licensing arrangements. When dealing with technology, companies may have many business reasons for licensing the information in foreign countries rather than providing the technical services directly. Royalty income from licensing arrangements with distributors and producers in those countries is subject to U.S. tax; in addition, many foreign countries impose a flat withholding tax on such income. Because both the United States and the foreign country tax the same royalty income, generally an FTC is allowed against the taxes withheld by the foreign country.

Joint ventures. A joint business between a U.S. company and a foreign company can be structured as either a partnership or a corporate joint venture. A partnership joint venture operates much as a domestic partnership with all U.S. owners: Any foreign taxes the partnership pays flow through to the owners; thus, the U.S. participant can claim a credit for its allocable share of foreign taxes on its U.S. return. Similarly, the allocable share of operating losses flows through to the U.S. participant and may be deducted.

A corporate joint venture is more complicated, with different tax consequences depending on the percentage of the joint venture owned by U.S. owners and the type of income or assets involved.

Foreign branch operations. It may be most convenient simply to set up a foreign branch operation of an existing U.S. company; such a branch is not considered a separate entity. Branch operating profits are included as income on the U.S. company's U.S. return; losses are deducted against U.S. income (an attractive feature during the business's beginning years when losses are more likely). However, deducting losses against U.S. income can result in the recapture or curtailment of the FTC in later years. Note also that, while most countries tax nonresident companies' branch profits the same as resident company profits, other countries impose heavier tax burdens on branch operations.

For a detailed discussion of the issues surrounding global expansion, see "Tax and Accounting Aspects of Global Expansion" by Ernest Larkins, Ellwood Oakley and Gary Winkle, in the June 1999 issue of The Tax Adviser.

Nicholas Fiore, editor The Tax Adviser