Posted by Elliot Kravitz, ATP

Necessary Concepts to Know in International Tax Matters

Necessary Concepts to Know in International Tax Matters

It is no news, nor will it come as a shock to anyone that more companies are entering the global market, including small and medium-sized businesses. Deliberate expansion into a promising market or just part of many successful businesses includes business transactions with foreign entities.

International business requires a basic understanding of the tax issues that arise when doing business in foreign countries. Without a clear picture of the tax ramifications of certain businesses, you can pay significant amounts of tax in the United States and abroad or face IRS penalties.

Given this, below is an overview of tax concepts relevant to international businesses. For specific tax and legal advice, consult an experienced tax lawyer familiar with international tax matters.


Permanent Establishment

The United States and many other countries tax international corporations on a “permanent establishment” basis. A permanent establishment does not necessarily mean owning, renting, or being physically present in a foreign country. Instead, the United States has entered into tax treaties with most of the countries in which you will operate, which set out the conditions under which it is considered a permanent establishment in a foreign country.

In some cases, understanding these requirements can help you avoid a permanent establishment.


Transfer pricing

Transfer pricing is one of the most important issues you need to resolve regarding international tax obligations. Transfer pricing occurs when two companies under the same umbrella negotiate across borders. The IRS will check for companies suspected of improperly transfer pricing. This is why it can be important for businesses to understand the difference between E.U. value-added tax and U.S. income tax, as an example.


Foreign Earning

Income that your business earns abroad may or may not be taxable in the United States.

If the business entity you are doing business with is a foreign corporation, U.S. taxes are generally deferred until the income is distributed as dividends or “repatriated” to U.S. shareholders.

In response to many U.S. corporations that have subsequently deferred significant tax benefits, Congress passed Chapter F. In Chapter F; tax deferrals are eliminated in certain categories of foreign income.

Also, keep in mind that the United States does not generally tax companies that do not receive income from the United States or do business in the United States. However, all U.S. citizens must pay income tax, regardless of the source of income.


FATCA and FBAR

To ensure that U.S. citizens pay foreign income taxes, Congress passed the Foreign Accounts Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR). While the full scope of these laws is beyond the scope of this article, please note that the United States continues to collect foreign income for U.S. citizens aggressively.


Social security taxes and withholding taxes

Withholding taxes for employees working outside the United States can be complex. The good news is that the United States has negotiated with 21 other countries to withhold taxes, such as Social Security and Medicare, to avoid double taxation of social assistance programs.


Conclusion

This brief introduction is provided to indicate initial considerations for expanding overseas businesses or receiving income from affiliates overseas. This article does not constitute legal or financial advice. If you have questions about the best way to use foreign branch tax deferrals, avoid a permanent establishment, or manage your tax obligations, contact an accountant or lawyer experienced in international tax law.


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Elliot Kravitz, ATP
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