U.S. Tax Structure
In terms of business structure, there are several forms to select. An important element in selecting the proper structure is understanding the related tax characteristics.
In general, the U.S. has a two prong system for taxing the U.S. source income of foreign persons:
- Income derived from the conduct of a U.S. trade or business is taxed on a net basis at the regular graduated rates, and
- U.S. source investment-type income is taxed on a gross basis at a 30% rate. However, this 30% tax rate is subject to various exceptions that reduce or eliminate the U.S. tax, such as treaty exemptions, capital gains relief, and the portfolio interest exemption that often eliminates or substantially reduces the tax.
Though there are several alternative structures, including establishing a branch, partnership, corporation, and limited liability company (LLC), for U.S. subsidiaries of foreign companies, there are really only two structures to consider; the corporation and the limited liability company (LLC).
S Corporations are common structures for domestic corporations but are not eligible entity structures when there are foreign owners.
The U.S. rules are often flexible in that they allow the taxpayer to select the desired tax status of the entity under the “check the box” regime. If established correctly, this allows the taxpayer to elect either “flow-through” taxation or corporate taxation.
Similar in structure to a German AG, the U.S. corporation permits unlimited classes of capital stock, profits are taxed at the corporate level, and shareholders pay taxes on dividends, unless wholly or partly exempt. Dividends remitted back to Germany are subject to a 0%, 5%, or 15% withholding under the German tax treaty.
Corporations incorporated in the U.S. are subject to taxes on their worldwide income. The U.S. taxes at graduated rates and generally a corporation is required to pay its tax quarterly.
Limited Liability Company (LLC)
Somewhat similar to a GmbH, U.S. federal tax law (and most states) permit an LLC structure which results in partnership tax treatment (i.e., to be taxed as a company) while maintaining the limited liability of the owners. This is a very flexible structure and is often used in joint ventures.
The tax on income is the same as the regular corporate tax, except that an additional branch profits tax is imposed to equalize the tax treatment of a U.S. branch of a foreign corporation with the U.S. subsidiary of a foreign corporation. For German companies, the branch profits tax generally equals 5% of the branches annual “dividend equivalent amount.” The dividend equivalent amount equals the branch’s earnings and profits effectively connected with a U.S. trade or business, reduced by any increase in U.S. net equity.
The reporting requirements for an LLC are more comprehensive than a corporation. In addition, quarterly tax payments are required in connection with any earnings allocated to foreign owners.
If a foreign company establishes operations in the U.S., but does not establish a U.S. legal entity, the operations will be taxed as a branch. The branch is generally subject to U.S. income tax on effectively connected income at graduated income tax rates. In a manner such as the LLC, a branch profits tax will also be imposed at a 0%, 5%, or 15% rate under the German tax treaty. A branch often allows the foreign company to deduct losses in the home country; however, Germany restricts deducting foreign losses.
A significant disadvantage of establishing a branch is that legal liability is not limited to the U.S. operations.
There is no national corporate law in the U.S. governing privately held corporations. Each state has its own form of corporate law, which permits an entity to be formed that insulates the shareholders from liability for debts of that entity. There is no requirement that a corporation be formed in the state in the U.S. where the subsidiary has its headquarters.
The U.S. does not impose any minimum capital requirements when establishing a U.S. trade or business. However, limitations are imposed on deductibility of interest expense to a related company when the debt to equity ratio exceeds 1.5 to 1.
The U.S. does not impose a VAT tax. However, most states impose sales and use taxes. There are often several exemptions including exemptions for manufacturing and industrial processing.
Tax Registration – An officer of the corporation must file for an employer identification number (“EIN”) with the Internal Revenue Service prior to commencing business. They must also register in states that they plan to operate.
Federal Filings – The U.S. Department of Commerce, Bureau of Economic Affairs requires foreign direct investment in the U.S. to be reported for statistical purposes. A Form BE-13 Claim for Exemption must be filed for any acquisition, establishment, or expansion by a foreign entity in the U.S. when the cost of the transaction is $3 million or less.