There are many strategies that internationally active U.S. companies can exercise to minimize their worldwide effective tax rates. One such strategy is to be diligent about charging out expenses to your foreign branches and foreign flow-through entities.

For illustration purposes, think of the very popular business structure of a U.S. company that has a “check the box” foreign entity of which the profit or loss, and the foreign tax credit, passes through directly to the U.S. tax return. Let’s also assume that the U.S. entity employs an individual who does all of the foreign entity accounting duties in the U.S. You may ask why does it matter if I charge the foreign entity for the accounting work provided by the U.S. person since all of the income and expenses end up on the U.S. tax return anyway? Not to mention I get a foreign tax credit for the taxes paid in the foreign jurisdiction. The answer is that it matters for several reasons with respect to utilizing the most effective and beneficial international tax strategy.

It’s true that those accounting expenses end up on the U.S. tax return whether you charge them to the foreign entity or not, but reducing the taxes paid in the foreign country by pushing down those expenses that belong in that foreign country has many benefits. First, this helps avoid a situation of having excess foreign tax credits that may potentially expire sometime in the future. Second, it could potentially reduce your worldwide effective tax rate. There are many real examples of companies with an overall taxable loss on the U.S. tax return, but the foreign entity is profitable. In this situation it is particularly important to make sure those expenses related to the foreign entity are pushed down in order to reduce the tax liability in the foreign country. This does not change the fact that there is a taxable loss reported on the U.S. tax return. Had those expenses not been pushed down, more taxes would have been paid in the foreign country while still reporting a U.S. taxable loss. Third, pushing down those expenses more clearly reflects the profit and loss situation in both the U.S. and the foreign country on a separate financial reporting basis.

When looking at the expenses reported by your U.S. company, consider the following:

• Are there any salaries and wages of U.S. persons who worked on the foreign financials, trial balance, or general ledger accounting? What percentage of their time was spent on this?

• Are there any travel related costs to go to the foreign country for business meetings, inspections, etc.?

• Are the worldwide sales staff and purchasing staff all in the U.S.?

• Are there any bank fees or other administrative charges related to the foreign country accounts?

• Were there any supplies, software expenses, repairs and maintenance expenses, or other services performed in the foreign country where the invoice was received in the U.S. and recorded on the U.S. books?

Initiating this international tax strategy may take some leg work by analyzing the different expense categories on your U.S. trial balance, but in the long run it’s a useful and beneficial exercise. Is your international tax strategy giving you the most benefit possible?

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Tax Benefits for Exporters

by Jerry Jonckheere on February 13, 2014

The U.S. tax code contains a number of incentives for desirable activities that U.S. taxpayers can engage in.  Some of the incentives can come and go at the whim of Congress, like the research & development credit, but the one incentive that has remained relatively unchanged since 1971 is a benefit for U.S. exporters.  That benefit reduces the effective tax rate on export profits by up to 10% by converting ordinary income into qualified dividends.

To illustrate how the benefit works, please refer to this example:

USCo is an S-corporation that has a profit of $1,000 on products it exports.

If USCo does not have a DISC, its shareholders would pay up to $1,000 * 40.5% or $405 in income taxes.  The 40.5% rate is from the highest individual tax bracket rate of 39.6% plus the 0.9% Medicare surtax.  The taxpayers have an effective tax rate of 40.5%.

If USCo forms a DISC, USCo could pay up to $500 in commissions to the DISC.  The commission deduction reduces USCo taxable income and replaces it with a dividend paid by the DISC.  USCo’s shareholders would pay only $321.50 in income taxes (i.e. $500 * 40.5% plus $500 * 23.8% rate for qualified dividends).  The taxpayers have an effective tax rate of 32.2%.

While the mechanics may look complicated, running the DISC is quite easy.  To claim the benefit, the taxpayer must:

  •  Form a separate entity that meets the requirements of a DISC
  • Identify qualifying export sales
  • Determine the profit on the export sales
  • Pay commissions quarterly to the DISC while the DISC also pays dividends quarterly
  • Comply with other statutory rules

If you are an exporter that wants to reduce your effective tax rate on export sales, a DISC is a proven strategy that can help you meet your goal.

Leave your comments below! Meet the author – Jerry Jonckheere

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Are There Hidden Costs Within Your Global Structure?

January 24, 2014

There are a variety of concerns when considering an international structure, from regulatory requirements and income tax efficiency to ease of moving capital or even employee benefit impacts. However, one that rarely seems to enter into the decision-making process is statutory audit and financial statement requirements. A previous blog post on September 30, 2013, discussed […]

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What do Apple and Amazon have in common?

January 7, 2014

a. They’re both headquartered on the West coast. b. They both started in garages. c. Their stocks have both seen incredible growth over the years. d. They’ve both been scrutinized by the government for their international tax strategies. Although all four statements are true, it’s “D” that we’d like to direct your attention toward today. […]

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FATCA Withholding Begins in July 2014 – What does that mean and what should be done to prepare?

December 23, 2013

One of the hottest topics of discussion among international tax practitioners and multinational business as we enter 2014 is the continued implementation of the Foreign Account Tax Compliance Act, or FATCA.  We have already seen some of the aspects of FATCA with the introduction of Form 8938 for individuals, the issuance of new draft W-8’s […]

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Simplified Repatriation Procedure in China

November 25, 2013

One consistent topic of frustration for U.S. investors into China is the process required to repatriate cash back to the U.S.  However, reforms issued by China’s State Administration of Foreign Exchange (SAFE) should help simplify the process.  As of September 1, 2013, the new process for repatriation is in place, covering payments other than amounts […]

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Mexican Tax Reform – Are you prepared?

November 11, 2013

On October 31, the Mexican Congress approved a tax reform package that will take effect in 2014.  Although the new tax on junk food should not affect most U.S. business in Mexico, many other provisions will.  First, the Mexican minimum tax commonly called IETU, has been repealed.  This should be a benefit for most U.S. […]

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What Will Happen to International Tax Planning?

October 14, 2013

International tax planning has come under much scrutiny over the past several months. In fact, the Organization for Economic Co-operation and Development (OECD) recently issued a report proposing an action plan to limit the arbitrage opportunities for tax planning between multiple jurisdictions. The focus is not just on the effort to avoid double taxation of […]

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Statutory Audits | What They Are & What They Are Not

September 30, 2013

Internationally active companies likely have subsidiaries that undergo annual statutory audits.  What many companies don’t understand is what that statutory audit really is.  Unlike the United States where audits are only required for public companies and certain other regulated entities while generally being optional for private companies, many foreign countries legally require most companies, including […]

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Auditor Rotation Abroad and at Home

September 16, 2013

There is much worldwide debate over auditor rotation and whether it has a positive or negative impact on the quality of financial reporting.  The debate principally revolves around public companies but if the concept becomes a well-accepted part of the U.S. or global financial reporting system it’s not too hard to imagine it beginning to […]

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