The United States is still one of the largest recipients of foreign direct investment and remains an attractive location for inbound businesses. A large amount of this investment comes from places like Japan, Canada, Australia, and the European Union.
One of the obvious reasons for this is the abundant opportunities to be found there, which is 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 famed for its sophisticated (and highly complex) tax system. With extensive tax regulations, all businesses that operate in the US will be subject to tax coverage in some shape or form. As a Japanese inbound business or 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 tax, we’ve outlined some of the major considerations that all businesses operating here should make, whether you’re simply operating a representative office or establishing a full subsidiary, distinct from your 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, collects taxes, and delivers collected taxes to the US Treasury, which makes its way to the various government departments that use it to run the country.
While the process is relatively predictable, the US has one of the most challenging tax systems in the world for new businesses and individuals. 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.
The US does not impose a value added tax or stamp duty like other nations, but each person will be required to adhere to income tax specific to their status. This also extends to all organizations and companies located or operating here in some capacity. Ultimately, tax must be calculated and reported, even if you are exempt in any way.
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 Has to Pay?
US individuals, corporations, and their foreign branches must pay US federal, state, and local taxes on their worldwide 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 must be associated with 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.
How Much is US Corporate Tax?
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. And, taxable corporate profits are equal to a corporation’s receipts, minus allowable deductions, such as wages, depreciation, and advertising costs.
Who Is Tax Exempt?
Foreign corporations that are not engaged in a US trade or business are not subject to US corporate taxes. However, foreign corporations that have US source income can in some cases be subject to both US and foreign tax. Similarly, US corporations that own an interest in foreign corporations are subject to US taxes on those foreign earnings (including passive income over a certain threshold) as well as the tax obligations that apply in the foreign jurisdiction.
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
Understanding 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. And in theory, there is nothing to stop corporations from optimizing their activities to reduce their total taxable income. Below are a few ways your company can reduce its payable tax.
Expenses required for the general operation of a business are fully tax-deductible. This includes all expenses incurred through ordinary business and trade, such as employee salaries, health benefits, tuition reimbursement, and bonuses. Also, businesses can reduce their taxable income by deducting travel expenses, bad debts, interest payments, sales taxes, and fuel taxes.
The expense of purchasing a fixed or tangible asset can be spread out over a number of years when it is depreciated. Businesses can either deduct the entire cost in the first year as an expense, or it can depreciate it and write the asset’s value off over a period of time. Deduction for depreciation is available for the cost of most assets with a life of more than one year used in a trade or business.
The expense of purchasing a fixed or tangible asset can be spread out over a number of years when it is depreciated.
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.
When opening a representative office, you do not have to incorporate a separate legal entity. As such, you will not be liable to pay any US corporate tax on income, as long as your activities are limited. Partially because of this, a representative office is the easiest option for a company starting to do business in the US for the first time.
Typically, foreign entities will establish a representative office to engage in market research, promotional activities, advertising, and general support activities that can facilitate future operations in the country. For companies that are in their early stages of expansion to the US market, it is often the most appropriate set up that can pave the way for a later transition towards a branch or subsidiary structure.
A branch structure also does not require you to incorporate a separate legal entity, however, due to the increased activities you are allowed to perform, this will constitute a taxable presence. With a US branch, you will be required to file US corporate taxes on profitable 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 for your branch incorporation carefully with the help of international tax accountants who can plan strategically for your whole business, even across borders and between different jurisdictions.
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.
Distributors and Manufacturer’s Representatives
Subsidiaries are usually broken up into two groups: distributors or manufacturer’s representatives. Both sell goods made by manufacturers from a foreign entity, and neither is directly employed by those manufacturers. Instead, they operate independently. The key difference is that the distributors actually buy and sell goods, while representatives act primarily as sales agents. Both are considered to have a taxable presence in the US and will be treated accordingly.
When two or more individuals or businesses work together on a single project, they may declare the project to be a joint venture, which is formalized by the signing of a joint venture agreement. This contract will specify the rights and obligations of each party involved.
In terms of US corporate taxes, any profits made from the joint venture will be taxed through the individual based on the portion of profit allocated to each member. This will relate to their individual or corporate tax returns and tax is not required on the profits of the venture independent of its members.
As an inbound company, you may want to invest directly in the US, or you may choose to make investments using tax-friendly intermediaries. These intermediary holding companies can significantly help to reduce taxes and using them to your advantage can help support the overall activities of your current or future expansion plans.
However, it is important to note that any holding company structure established solely for minimizing taxes in the US can expect to be challenged by the IRS.
LLCs and LLPs
Both LLCs and LLPs help business owners limit their personal liability, meaning owners may lose the money they have invested in the company, but their personal assets are not at risk if the business is sued. An LLP is taxed like a general partnership with the partnership reporting business income and expenses on a partnership tax return. Each partner reports a share of the profits or losses on his or her personal return.
An LLC with more than one member is also taxed like a general partnership, but a single member LLC is taxed as a sole proprietorship. However, all LLCs have the ability to choose corporate taxation instead, if they so wish. This is one of the main benefits of an LLC compared to an LLP.
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
An approved tax treaty between Japan and the United States is in place. It helps taxpayers decide which country to pay taxes to and helps prevent dual taxation. In most cases, it is the residency status that determines the country that receives taxes. However, tax treaties can be incredibly complex, so it is always advisable to consult a professional tax advisor.
|Japan corporate income tax rate||
(Plus additional relevant taxes for corporations)
|US corporate income tax rate||
(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
Short Term Contracts
Another common tax pitfall arises from the hiring of employees or using foreign employees within the US. Essentially, employees living and working outside their home country are typically referred to as expatriates and taxed accordingly. However, when the employee or contractor is sent to the US for only a short-term, there is a gray area where sometimes there is no formal agreement on how tax is handled.
Aspects such as duration of stay, compensation, and activities can mean you have effectively created an expatriate, and if they are not taxed properly, you may be penalized by the IRS.
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.
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