doing business in the United STate using a domestic corporation
It is common for foreign corporations to operate in the United States through a corporate subsidiary that is incorporated in the United States. This structure is popular because of both business and tax considerations. The primary business considerations include limiting the claims of U.S. creditors on assets of the foreign parent limiting the amount of foreign parent financial information subject to review by U.S. taxing authorities, and the idea, whether real or imagined, that U.S. customers and business partners prefer to do business with domestic corporations.
As a general rule, it does not make a significant difference from a U.S. tax perspective if a foreign corporation directly earns U.S. business income or if it earns U.S. business income through a domestic subsidiary. If the income is earned directly by the foreign corporation, it will be subject to income tax at graduated corporate tax rates and branch tax on remittances of profit to the home office. If the income is earned through a domestic subsidiary, it will be subject to income tax at graduated corporate tax rates and dividend withholding tax on dividends paid to the foreign parent. Since the dividend withholding tax and the branch tax are essentially equivalent, the overall U.S. tax burden is typically the same.
There are two common exceptions to this general rule. The first exception applies to a foreign corporation that qualifies for benefits under an income tax treaty, earns business income in the United States, and whose presence in the United States does not rise to the level of a permanent establishment. In this case, it will be beneficial for the corporation to conduct its U.S. activities itself or through a subsidiary incorporated in its home country. This is because the permanent establishment provisions of the income tax treaty exclude its U.S. business income from U.S. taxes. If this income was earned through a domestic subsidiary it would be subject to U.S. taxation regardless of the fact that there is no permanent establishment in the United States.
The second exception involves situations where a substantial amount of capital will be required for the U.S. operations and the capital will be financed out of the accumulated earnings of the foreign corporation. In this case, the use of a domestic corporation may be beneficial because the foreign parent could provide a portion of the capital in the form of interest-bearing debt instead of equity. The use of debt in the subsidiary's capital structure will allow U.S. taxable income to be reduced by interest payments to the foreign parent and allow for repatriation of capital in the form of tax-free principal payments instead of taxable dividend payments. The benefits of using debt are limited by interest-stripping provisions contained in U.S. tax law, but such structures are usually viable when U.S. operations are profitable and debt levels are kept to reasonable levels.
Tax considerations in the foreign corporation’s home country may also come into play when determining whether to house the U.S. operations in a domestic subsidiary. The exact nature and extent of these considerations will depend on the country of incorporation of the foreign corporation, but common issues revolve around whether start-up losses can be deducted by the foreign corporation in its home country and how earnings repatriation is taxed by the home country.
As a general rule, it does not make a significant difference from a U.S. tax perspective if a foreign corporation directly earns U.S. business income or if it earns U.S. business income through a domestic subsidiary. If the income is earned directly by the foreign corporation, it will be subject to income tax at graduated corporate tax rates and branch tax on remittances of profit to the home office. If the income is earned through a domestic subsidiary, it will be subject to income tax at graduated corporate tax rates and dividend withholding tax on dividends paid to the foreign parent. Since the dividend withholding tax and the branch tax are essentially equivalent, the overall U.S. tax burden is typically the same.
There are two common exceptions to this general rule. The first exception applies to a foreign corporation that qualifies for benefits under an income tax treaty, earns business income in the United States, and whose presence in the United States does not rise to the level of a permanent establishment. In this case, it will be beneficial for the corporation to conduct its U.S. activities itself or through a subsidiary incorporated in its home country. This is because the permanent establishment provisions of the income tax treaty exclude its U.S. business income from U.S. taxes. If this income was earned through a domestic subsidiary it would be subject to U.S. taxation regardless of the fact that there is no permanent establishment in the United States.
The second exception involves situations where a substantial amount of capital will be required for the U.S. operations and the capital will be financed out of the accumulated earnings of the foreign corporation. In this case, the use of a domestic corporation may be beneficial because the foreign parent could provide a portion of the capital in the form of interest-bearing debt instead of equity. The use of debt in the subsidiary's capital structure will allow U.S. taxable income to be reduced by interest payments to the foreign parent and allow for repatriation of capital in the form of tax-free principal payments instead of taxable dividend payments. The benefits of using debt are limited by interest-stripping provisions contained in U.S. tax law, but such structures are usually viable when U.S. operations are profitable and debt levels are kept to reasonable levels.
Tax considerations in the foreign corporation’s home country may also come into play when determining whether to house the U.S. operations in a domestic subsidiary. The exact nature and extent of these considerations will depend on the country of incorporation of the foreign corporation, but common issues revolve around whether start-up losses can be deducted by the foreign corporation in its home country and how earnings repatriation is taxed by the home country.