The United States is still one of the largest recipients of foreign direct investment and remains an attractive location for foreign businesses. A large amount of this investment comes from places like Japan, Canada, Australia, and the European Union.
One of the main reasons attracting investment is that it is home to the world’s largest economy. Excellent infrastructure; legal protection for corporations; a productive and skilled workforce; and lucrative consumer markets across several sectors make it an attractive place to do business.
Having said that, the US is also known for its highly complex tax system. With extensive tax regulations, all businesses that operate in the US will be subject to its tax laws. As a Japanese outbound business or an entity growing your presence in the US, you will need to navigate your way through sometimes vague and confusing tax requirements on a national, state, and local level.
To help you avoid some common pitfalls when it comes to US corporate taxation, we’ve outlined some of the major considerations that all businesses operating in the US should make, whether you’re simply operating a representative office or establishing a fully owned subsidiary of the parent company.
A Quick Glance at the US Corporate Tax Landscape
In the US, the Department of the Treasury issues regulations that interpret tax laws, and the Internal Revenue Service (IRS) enforces these tax laws and collects tax for the US Treasury.
The US has one of the most challenging tax systems in the world for new businesses and individuals. Along with federal tax regulations and authorities, there are also state and local tax implications that you need to keep in mind.
The US does not impose a value-added tax or stamp duty like other nations, but each person or entity will be required to adhere to income tax laws specific to their tax status. This applies to all organizations and companies located or operating here in any capacity. Even if the entity is exempt from taxation it may still be subject to reporting requirements.
As well as federal tax regulations and authorities, there are also state and local tax implications that you need to factor into your tax activities in the US.
Fundamentals of US Corporate Tax
Each individual and business has a unique set of requirements that will create tax obligations specific to their circumstances. When entering the US or expanding your operations here, remember that each activity or transaction that takes place in your business could impact your tax position.
Who must pay tax in the US?
Corporations operating in the United States are required to pay federal corporate tax, state, and local taxes based on their taxable income. However, US branches and partnerships are subject to US tax only on their income that is effectively connected to a US trade or business (ECI) or income that is fixed, determinable, annual, or periodic (FDAP) such as interest, dividends, rents, and royalties.
The ECI applies to US-based activity that is considered at the level of a US trade or business, including a branch of a foreign corporation. A general definition of a US trade or business is an entity that performs certain activities in pursuit of profit that is considerable, continuous, regular, and substantial.
What is the US Corporate Tax Rate?
The United States imposes a tax on the profits of US resident corporations at a rate of 21%. This was reduced from 35% by the 2017 Tax Cuts and Jobs Act (“TCJA”). Taxable Income is equal to a corporation’s receipts, minus allowable deductions.
The United States imposes a tax on the profits of US resident corporations at a rate of 21%.
How to Determine and Reduce Taxable Business Income
Determining how much tax you need to pay is a crucial process all businesses must engage in. Equally, finding ways to reduce unnecessary tax obligations is also important.
Expenses required for the general operation of a business are deductible for book purposes. This includes all expenses incurred through ordinary business and trade, such as employee salaries and bonuses. However, some expenses such as entertainment expenses are not deductible for tax purposes.
Depreciation is another example of an expense that has a difference between book and tax. The expense of a purchased fixed or tangible asset can be spread out over several years when it is depreciated. For tax purposes, it may be possible to deduct the entire purchase cost if certain conditions are met. Deduction for depreciation is available for most assets with a life of more than one year used in a trade or business.
Businesses do not always earn a profit. This is particularly likely when you are starting up your enterprise in the US for the first time or during times of economic hardship. However, this does not mean you need to throw in the towel, and you may be able to obtain significant tax relief to keep you moving forward until time of more financial prosperity.
Types of US Entities and Tax Implications
There are a number of ways in which your company can structure business activities in the US. Depending on your inbound business model, the way your operations are structured will define how you will be taxed, so making the right choice can have a huge impact on your profitability as an organization.
A branch structure does not require you to incorporate as a separate legal entity.
Under the Japan-US tax treaty, a federal tax is not applicable to business profit conducted without a permanent establishment in the United States. As long as a business activity is limited as described in the treaty, it will not be treated as having permanent establishment, so there is no obligation to pay federal corporate tax on that income. Typically, a representative office is facilitating future business operations in the US, such as market research, promotional activities, and advertising, it would be a good way to set up your US business in its early stages.
However, if you increase your business activities of the US branch, this may constitute a taxable presence or permanent establishment in the US. In this case, you will be required to pay US corporate taxes on taxable income for the branch.
Careful consideration should be taken on the branch structure as it can affect your parent company, potentially exposing it to additional tax obligations on its profits, due to a higher tax rate. It is advised to plan your branch incorporation carefully with the help of international tax accountants who can plan strategically for your worldwide operations.
In a subsidiary structure, a company incorporates a wholly owned subsidiary in the US. This effectively makes it a separate legal identity that is distinct from the parent company. While this has the advantage of limiting any risks that can be caused by a branch company on its parent company, all profits earned by the US subsidiary will be liable to US corporate taxes.
For tax purposes, LLCs pass through their income to investors called members. Since it is taxable to the investor, double taxation does not occur, which is the main advantage of the LLC. Another advantage of the LLC is that you can elect to treat it as a corporation. LLC is a small corporation, so it is not suitable for large-scale business development.
Intermediary holding companies can significantly help to reduce tax and using them to your advantage can help support the overall activities of your current or future expansion plans.
Additional US Corporate Taxes to Consider
In addition to the activities and structures that generate federal corporate income tax liability, companies are also subject to relevant state, regional, and local taxes. This will depend largely on where they are located and how they choose to conduct their operations.
State and Local Taxes
US corporate tax obligations can differ significantly depending on which of the 50 individual states your business operates in. Each state can have its own tax laws and regulations specific to each tax jurisdiction. Interestingly, several important indirect taxes are imposed at the local level and not national, such as gross receipts and business personal property taxes.
Further to this, certain incentives and benefits might be available for your business depending on which state you are in. For example, tax credits and initiatives have been designed to boost investment in certain locations to stimulate parts of the economy. Understanding and using these to your advantage is all part of the process of efficiently operating in the US.
Many foreign entities struggle with transfer pricing and transfer pricing agreements when doing business with the US. Essentially, companies must establish suitable prices at which services, goods, and intellectual property is transferred between affiliate components of a multinational enterprise.
These transfer pricing practices are subject to complex tax regulations that could significantly impact the way business is conducted across borders. As pricing decisions determine where profit is allocated and subsequently how taxes are paid, increasing attention is paid to these processes by tax authorities worldwide, including the US.
There is no federal sales tax or value-added tax in the US. However, most states levy sales taxes, which are typically assessed on the final consumer purchase. The total sales tax can vary considerably due to different local rates.
Transfer pricing practices are subject to complex tax regulations that could significantly impact the way business is conducted across borders.
Advice for Inbound Japanese Corporations
As tax systems are extremely complex and intricate, it is hard to draw an easy comparison between any two nations, especially those as unique as the US and Japan. However, there are a few things that should stand out to you as a prospective Japanese business considering doing business in the US.
- Taxes payable by businesses can vastly differ depending on their activities. It is possible to have minimal business activity and decision making in the US, with relatively low tax obligations, or a larger presence, with equal tax responsibilities.
- Different source rules apply to different types of income. And if a source of income cannot be determined, treatment will default to that of a US source and will be subject to US taxation.
- The Customs and Border Protection (CBP) agency enforces strict laws around customs duties, taxes, and fees, making it critical for inbound businesses to factor this into their US market entry strategies.
- Many US states impose sales or use local taxes in addition to corporate taxes. Each state’s tax laws are administered and enforced by a state tax agency.
- Several states offer benefits or incentives for inbound investors, particularly for local manufacturing activities.
- The US government imposes excise taxes on a wide range of goods and activities, including air travel, gasoline, and diesel fuel used for transportation and manufacturing of specified goods.
- Corporations (other than S corporations and specific structures exempt from tax) accumulating earnings and profits for the purpose of avoiding shareholder personal income tax could be subject to a penalty tax in addition to any other taxes that may be applicable.
US-Japan Tax Treaty
There is a tax treaty between the US and Japan that is in effect. It helps taxpayers determine which country to pay taxes to and helps prevent double taxation. In most cases, it is the residency status that determines the country receives the tax.
Tax treaties can be incredibly complex, so it is always advisable to consult a professional tax advisor.
|Japan corporate income tax rate||23.4%(Plus additional relevant taxes for corporations)|
|US corporate income tax rate||21%(Plus additional relevant taxes for corporations)|
Potential US Corporate Tax Pitfalls
At HLS, we have seen even the most well-prepared and sophisticated enterprises face common US corporate tax pitfalls. Sometimes this occurs due to the lack of understanding in handling nuanced tax criteria, while at other times it is simply down to small misconceptions about how tax laws are applied.
One of the worst tax consequences to face as a large and expanding corporate entity is double taxation. This is the result of two or potentially more tax jurisdictions claiming a portion of taxes from your profits. And this often stems from disagreement or controversy about how transfer pricing is arranged.
Typically, advanced planning is enough to mitigate these situations, but in some cases, more spontaneous countermeasures are required to make sure you are not disproportionately taxed across your international operations and profits. This is where having an expert team of international tax accountants and consultants really proves its value. Contact Us for Tax Advisory Services
Mistakes and Communication Issues
With corporate tax being a complicated field to understand, let alone discuss in different languages, there are many areas where confusion or misinterpretation could arise when working with a local tax advisor. The important thing is to have a good level of understanding between you and the team who will be handling your taxes, whether that is an internal or external team. Making sure everything is crystal clear from the start will help you prevent any costly mistakes from occurring.
A Lack of Human Resources
Even if your internal tax team is highly competent in handling cross border tax issues between Japan and the US, sometimes the workload can be too much to handle without additional support. Whether it is calculating important financials or filing the correct reports, not having sufficient human resources and experts on hand to help with your US corporate taxes can cause significant delays in your processes.
Moving Forward with Your US Corporate Tax Strategy
At HLS, we know more than most that every business, multinational corporation, partnership or individual has a unique set of circumstances and attributes that trigger specific tax obligations. Sometimes, the nature of your operations can leave you exposed to tax obligations beyond what you were initially aware of or prepared for.
Nevertheless, when armed with enough professional expertise and overarching policies for managing international taxes, the process of doing business in the US can be made much smoother. If you are looking for more specific information about how US corporate taxes relate to your business, or would like to speak with one of our advisors, get in touch with us and we’ll do our best to help you fully understand the impact that the US tax regulations may have on your corporate entity.