Recently,
there have been news
reports that foreign
subsidiaries of U.S.
corporations do not pay
U.S. taxes, which has
people asking as to what
rules have to be met
for foreign subsidiary
income to be US income
tax-free.
The
truth is that those
articles would be more
accurate if they described
the earnings of foreign
subsidiaries of U.S.
corporations as tax
deferred instead of
as tax free. This does
not diminish the value
of tax deferral, but
merely clarifies what
is a frequent misunderstanding.
Generally,
a foreign subsidiary
of a U.S. corporation
(or a
U.S. citizen, partnership,
trust, etc.) is not
subjected to the current
U.S. tax on its foreign
source income unless
that income is within
the range of what the
tax law calls "Subpart
F income". Included in Subpart F income is nearly every type of passive investment income.
Also included is the
income of a foreign
corporation (owned
and controlled by U.S.
persons or entities)
derived from favorable
pricing in transactions
with related or affiliated
U.S. entities or persons.
With a typical foreign
subsidiary of a U.S.
corporation, the
foreign sub is a
resident in the foreign
country as well as
being licensed to
conduct business
in that country.
If the foreign country
imposes any kind
of income, employment
or value added taxes,
the foreign subsidiary
is subject to those
taxes just the same
as a local corporation.
The foreign corporation
is by and large independent
of the U.S. parent
company in the sense
that the foreign
sub has its own employees,
an office and the
facilities necessary
to conduct business
in the foreign country.
There
are, in some cases,
treaties between the
U.S. and other countries
that provide some tax
benefits to a foreign
based subsidiary of
a U.S. company.
As
mentioned in a recent
article about self
employment taxes for
U.S. citizens who are
living and working
in a foreign country,
a foreign corporation
may be advantageous
with respect to the
U.S. self employment
tax of an individual
living and working
outside the U.S.
A
foreign corporation
or IBC may be necessary
in some countries in
order to purchase foreign
investments. If that
should be the case,
the U.S. owner of the
corporation is usually
better off to elect
to have the
corporation taxed as
a disregarded entity
and to have the income
of the foreign corporation
flow through to the
owners personal tax
returns. The same applies
to a foreign limited
liability company.
Many
people, though, have
very short memories
about tax matters.
A long time ago, it
was legal for U.S.
citizens to own foreign
corporations and to
use those corporations
to invest in foreign
securities on a tax
deferred basis. But
in 1962 the rules were
changed and have since
been refined continuously.
Prior to 1981, the
top personal tax rate
in the U.S. was 70%
while, at the same
time, the top rate
on capital gains was
28%. The top rate on
corporations has been
as high as 50.75% and
is currently 35%. The
top personal income
tax rate is now 35%
with a top rate on
long term capital gains
and qualified dividend
income of 15%.
Many
articles found in international
tax literature suggest
that U.S. personal
tax rates are now lower
than in many foreign
countries while U.S.
taxes on U.S. corporations
are significantly higher
than in many
foreign countries.
For
non-corporate owners
of foreign corporations,
it is an advantage
to elect to have the
foreign corporation's
income taxed at U.S.
personal rates by making
an election to be taxed
as a foreign partnership
(multiple owners) or
as a disregarded entity
(one owner.)
Where
a foreign corporation
is owned by a domestic
corporation, the tax
deferral just described
is usually an advantage
over having to pay
current high corporate
taxes on that foreign
source income.
If
you would like more
information regarding
asset protection, trusts,
family limited partnerships
or the subject of this
article please call
or email our office.
