The US is an enormous market that offers tremendous opportunity. Recent changes to the American tax code make this market even more attractive, but there are still many differences that are important to understand when considering expansion into the US. Join Mike Whitacre and Malcolm Joy, two of our international tax experts, to learn about some of the tax implications of doing business in the US, including setting up an entity, state and local tax regimes and tax incentives.
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Making the jump to the US: What UK companies need to consider Transcript
This transcript was assembled by hand and may contain some errors.
It has been edited for readability.
Adelle: Welcome to Untangling the Technical, Frazier & Deeter’s podcast series in which we take a look at complex business issues and break them down for business executives navigating today’s complicated and ever-changing regulatory environment. I’m Adelle Erdman, and today I’m delighted to welcome two of the key partners in Frazier & Deeter’s international practice as we discuss expanding your business into the US market. Mike Whitacre is one of the lead partners in our international tax practice who frequently speaks at events around the world about expanding into the US.
Mike: Hi Adelle.
Adelle: We also have Malcolm Joy, the leader of Frazier & Deeter’s London office. Like Mike, Malcolm is also an expert in international tax planning, including value chain analysis and transfer pricing. Malcolm, Welcome.
Malcolm: Hello. Thanks.
Adelle: Today we want to talk about some of the big issues that European companies need to explore when they consider expansion into the US. Mike, one of the objectives of the recent US tax reform was to make doing business in the US more attractive from a tax perspective. What are some of the initial tax issues that companies face when they’re coming into the US?
Mike: The first issue that companies face coming into the US is determining if they actually need to file a tax return or not. A lot of businesses will sell their product into the US and not necessarily have to file a tax return. If the activity that they’re carrying on rises to a certain level, that’s what creates a tax filing requirement, because there’s a treaty between the UK and the US. That term is called establishing a permanent establishment, and that’s the first issue that comes up coming into the US.
Adelle: When UK companies organize in the US, what type of legal entity do they usually use?
Mike: Usually I see corporations, probably about 90, 95% of the time, C Corporations.
Malcolm: I think that’s right, Mike. I think typically we see corporations being the favored entity of choice for getting into the US. You can use a branch, but I think one of the advantages of the corporations is, it’s easier to ring fence the activities of a corporation and therefore ring fence the profit so that if there is any investigation into things like the transfer pricing arrangements, then if you’re using a branch, the risk is that the tax authorities in the US would be able to look right into the UK company’s accounts, and that just gives you more of a headache.
Adelle: When a company decides to come into the US, what is the process like to form a US entity?
Mike: That’s really a legal process, but usually that can be done in one to two days. So, after you decide what type of entity you’re going to select, it only takes about a day or two for the lawyers to actually form the corporation. You then have to go get a tax registration number in the US; that actually takes about 10 business days.
But one of the things that I always point out to people coming into the US is that lawyers in the US love to use limited liability companies or LLCs as we call them, and you need to be careful with that, because if you’re a UK company, for example, and you own 100% of an LLC, that is actually ignored for tax purposes. So, you might not be getting the result you’re expecting. So, the point there is if your attorney or whoever is forming the company puts you into an LLC, just make sure you get good tax advice on that also.
Adelle: Excellent. Well, I’m surprised, it doesn’t sound like it takes a terribly long time.
Mike: No I mean the US is actually very quick from that standpoint.
Adelle: Well, digging into it a little bit, what are some of the common mistakes that you see when a business decides to come into the US?
Mike: Some of these things are very simple, but they can be expensive. I mean, one of the mistakes is what we just talked about. People go into an LLC and don’t realize that it’s disregarded for US purposes. We’ve seen this before, they find out a year or two later they actually have a different tax profile than they were expecting, which can be fixed, but it can cause some complications.
The other common mistake that that we see is, for example, if a UK company owns a US company and then takes dividends or interest out, there’s reduced withholding rates under the UK-US treaty that you can get. But what’s supposed to happen is the UK company is supposed to provide a form to its subsidiary company, which is notifying the US company that it is in fact a UK tax resident, and it’s eligible for these lower withholding rates. That form does not have to go to the IRS. It goes to the subsidiary company, but a lot of companies just overlook this and don’t do it, take dividends or interest out, apply the reduced withholding. IRS comes in, examines the US company, doesn’t find the form, ten thousand dollar penalty. So that’s an example of a very simple thing, but it’s missed quite a bit. It can be expensive for the companies.
The flip side of that common mistake is that when the UK company or owner is using treaty benefits they’re supposed to file a form directly with the IRS. It’s a tax return, but there’s no numbers on it. It’s called the Form 1120F, and they’re supposed to disclose in there that they’re using the treaty benefits. Again, a lot of times, because it’s pretty simple it gets overlooked and gets missed. Ten thousand dollar penalty. So, we see this where companies may be operating in the US the subsidiary for two or three years, not realized they were supposed to be filing those forms and have twenty or thirty thousand dollars of penalties as a result of that.
Adelle: So there’s a lot of paperwork that really can add up on you. Little details. Is there anything about coming into the US that is really completely new for a UK company?
Malcolm: I think the main things that are different coming into the US for a UK company… The regime around state and local taxes. I think it’s something that the UK businesses are just not at all familiar with. And to be honest, it’s a little bit frightening when you’re coming into the US for the first time, and you’re perhaps aware that there’s quite a decentralized system in the US, with states able to charge taxes on slightly different bases, and it’s understanding when you have nexus, when you have an obligation to file a state tax return and how much tax is going to be at stake. I think all of those kind of things are really the most unusual features about UK companies coming into the US.
Mike: Yeah, I would agree with that, when I give presentations, that’s the part where it grabs everybody’s attention, when they realize we have 50 states, 3,007 counties in the US, and they can all tax these companies, and they’re all different regimes, potentially. But I always tell everybody for new companies coming into the US, generally the regimes are going to be income tax, property tax and sales tax.
But the one that concerns me the most for new companies coming in is sales tax, because that’s the US version of VAT, and it’s charged on turnover or revenue. So, some of these companies that come in, they’re losing a little bit of money in the beginning or not making a lot of money. If you mess up the income tax, it’s not a huge deal, but you could have a significant amount of revenue while you’re not making a lot of money. And if you’re subject to sales tax, again, you can get two or three years down the road and find out the company owes a significant amount because of the sales tax.
So, that’s the one that concerns me the most with new companies coming in, and I’ll also point out here that there’s been a sea change with sales tax in the US; we’ve had a recent Supreme Court decision called The Wayfair. Essentially, before Wayfair, you had to have physical presence in the state in order to be liable for sales tax. Now Wayfair allows the states to tax you with sales tax if you just have sales into their state, even without physical presence. So it’s something that companies really need to be aware of.
Adelle: So there’s a fair amount to think about in terms of the different federal, state and local tax regimes. What are some of the incentives that UK companies should be aware of as they come into the US?
Mike: They’re not special to UK companies, but I think they just need to be aware of them as any good business would coming into the US or starting their business in the US. The research and development tax credit is potentially a pretty lucrative credit. That’s a federal credit, and a lot of states also have their own credit. So, you can actually get two versions of that credit, potentially.
The other nice thing about that credit is if you can get under the guidelines for the federal credit and some of the states you can, even if you’re not making money and paying tax, you can monetize that credit, potentially, by offsetting payroll tax. So, even if you’re not making money and paying tax, you may be able to get a benefit out of the research and development tax credit. So, that’s a big one. I think any company, you know, also coming in, many states have jobs credits and other different credit regimes that are there to attract new businesses.
So, that’s also something that should be looked at. If you’re a manufacturing company or an asset intensive company, I wouldn’t define it as an incentive, but it is an incentive I think in the fact that under the new tax rules that came in about a year ago, you can expense 100% of most assets you acquire immediately. So, that provides a nice tax benefit also.
Adelle: As we wrap up, is there anything else that you think specifically UK companies should be thinking about as part of their US expansion?
Malcolm: I think Mike’s covered all the main points that are specific to the US. I think there’s just a couple of other things that UK companies would need to think about generally when expanding anywhere overseas. And that’s really just around the financing arrangements, whether you can put debt into the overseas territory and if so, how much.
And secondly, the transfer pricing, just how much profits would be allocated to that overseas entity and working out the basis of the transfer pricing, how the overseas entity would be characterized and then how the transfer pricing would be benchmarked and documented. There are things you have to do for every overseas expansion, but particularly for the US.
Adelle: Well I want to thank both of you for being on the podcast and for sharing all your insights. For our audience, thank you for listening to Frazier & Deeter’s Untangling the Technical podcast. Please join us for our next episode as we continue to discuss complex topics in terms that help you navigate your way forward.