There are many reasons why just about any company outside the United States would want to enter the U.S. market. For example, the U.S. has a predictable and transparent legal system. In addition, the U.S. government welcomes foreign direct investment. And to attract overseas investors, many U.S. states and local governments offer incentives and support innovative and collaborative initiatives.
But, that said, to use a colloquialism, expanding into the U.S. market can be tricky.
To raise awareness of these intricacies, Prager Metis recently co-hosted a panel discussion that addressed the important factors foreign companies need to consider when expanding into the U.S. market. The discussion produced “7 Tips for Navigating the Uncharted Waters of an Expansion into the U.S. Market.” And they are:
Tip #1: Decide if Setting Up a U.S. Entity Is a Must
To test the viability of not establishing a physical presence in the U.S., a firm can first try exporting its products or services to the United States and selling them through a U.S. distributor. However, if a company seeks to raise capital from U.S. investors, they may prefer the company have a U.S. presence, which may also be advantageous to B2B companies.
But when marketing from their country of origin, non-web-based companies can hire independent contractors to provide services on their behalf. E-commerce products and services can be sold over the web without creating “a federal taxable presence” by keeping a company’s server outside the U.S. and not soliciting sales or finalizing contracts in the U.S.
Tip #2: Carefully Choose a Geographical Location for a U.S. Entity
When selecting a state in which to form and operate, companies should consider the market fit for their product or services. Many companies and legal advisors favor forming companies under Delaware law for non-tax reasons, such as its modern corporate laws and the quality of its court system. Some states have higher taxes (New York, New Jersey, California) than others (Florida, Arizona). Some states have no corporate or business income tax at all but have sales tax.
Tip #3: Choose the Most Advantageous U.S. Business Structure
The main business structures available for foreign business entities in the Unites States are a corporation, a partnership, or a limited liability company (LLC).
Corporation – This is most common business form in the United States. Advantages of registering as a c-corporation include:
- Limited liability to directors, shareholders, officers and employees.
- High credibility in the eyes of suppliers, lenders and customers, and no limit to the number of shareholders.
- Unlimited potential for growth, and there may be some tax advantages.
Partnership – A partnership is typically not taxed, except possible taxes at the state level. Income or loss flows through to the partners, who are taxed on their proportionate share on their individual tax returns. Main downside: partnerships don’t provide partners liability protection.
Limited Liability Company (LLC) – An LLC is taxed as a partnership unless its members elect to treat it as a corporation for tax purposes. However, it offers its owners liability protection similar to that of a shareholder in a corporation.
Determining what type of entity to form depends to a large extent on whether there’s an expectation of income or losses. If income is expected in the U.S., the company should ensure that it can take advantage of foreign tax credits, and avoid double taxation, by coordinating the U.S. structure with the foreign structure. And if there are losses, the objective should be to ensure that the losses can be passed to the owner.
Tip #4: Leverage Treaties, Comply with Transfer Pricing
To achieve tax efficiency in cross border operations by leveraging treaties may involve forming a holding company in a different jurisdiction than the home country. Also, if the foreign company will be selling to the U.S. company, the companies must comply with transfer pricing rules, which require that intercompany transactions between related companies be conducted at “arm’s length.” But, transfer pricing can permit a company to generate most of its income in a lower tax jurisdiction and most of its expenses in the higher tax jurisdiction.
Tip #5: Know Where to Develop and Register Intellectual Property
Typically, owning intellectual property (IP) in a low tax jurisdiction is desirable because the company can license the IP to related and unrelated parties and generate the income at the lower tax rate. If the IP is NOT developed in a low tax country, opportunities may arise later to move it to a low tax country.
Tip #6: Know the Tax Implications of Bringing a Team of Employees from Home
When staffing a U.S. subsidiary of a foreign company, a team from the firm’s home country could be brought in. However, if the foreign employees are deemed agents of the foreign company, they could create a taxable presence for the U.S. company. Options include:
- Placing foreign employees on the U.S. company’s payroll.
- Or the foreign company giving the U.S. company rights to oversee the employees’ day-to-day activities and getting compensated for the employees’ services.
Tip #7: Know the Advantages of Making the U.S. Entity the Parent Company
Circumstances where it is advantageous for a foreign company to set-up the U.S. entity as the global owner of the business include:
- When raising funds, the venture capital funds, private equity or financial institutions may prefer to invest or lend to a U.S. company that is the parent.
- The current corporate tax rate of 21% is very competitive with most countries.
- Current tax rules allow manufacturing businesses to deduct their investment in tangible depreciable assets in the first year.
- A U.S. based corporation that sells goods or services to foreign customers, is allowed a foreign-derived intangible income (FDII) deduction that reduces the effective tax rate on qualifying income to 13.125%.
While expanding a business into the richest market in the world offers endless opportunities, as stated, it can be “tricky.” So, before taking even that first step, seek the counsel of accounting firms such as ours that understand the nuances of foreign expansion into the U.S. It not only avoids making obvious mistakes, it makes your venture almost certain to succeed.