RSM Resources

To lower costs, a U.S. company decides to manufacture its productsin China. But it’s not ready to commit to a wholly owned subsidiary. Soit negotiates a deal with a Chinese firm. Its Shanghai-based partnerprovides the factory and operating expenses; the Americans provide thetechnical expertise and intellectual property.

Both companies contribute assets to finance the joint venture. Later, they’ll share the profits. Done deal, right?

Not so fast.

U.S.law doesn’t permit a company to contribute intellectual propertytax-free. According to Jim O’Brien, a tax attorney with Baker &McKenzie in Chicago, companies would be wise to consult experts before,not after, negotiating a joint venture deal.

Many tax, tariff and trade complexities may affect a company’s worldwide tax burden, including:

"Permanent establishment" issues. Manynations have become increasingly assertive about taxing businessesoperating within their borders. But when does a U.S. business operatingin France, for example, become a permanent establishment? Is it whenthe firm hires a local to work at home, sell products and take purchaseorders? Or is it when the firm hires a salesperson to enter the countryonce a month for three days?

"There’s a lot of gray area," O’Brien says.

Membernations in the Organization for Economic Cooperation and Development(OECD) are attempting to agree on a uniform definition of a permanentestablishment. Meanwhile, companies should understand what constitutesa taxable, permanent establishment in the jurisdictions where they dobusiness.

Don’t assume establishing a subsidiary in a foreignjurisdiction will necessarily shield the parent company from taxation.Some countries attempt to tax both the subsidiary and the parent firm.

Tax treaties.U.S. government-negotiated tax treaties help Americans avoid doubletaxation when doing business internationally. The United States hasreached agreements with nearly 60 nations concerning how they tax U.S.citizens and corporations. Those countries include Australia, China,Israel, Japan, Norway and Turkey.

Tax treaties clarify acompany’s tax obligations. However, countries sometimes renegotiatethese treaties, so it’s important to keep up with possible changes. Fora complete list of tax treaties between the United States and othernations, go to: http://www.irs.gov/businesses/international/article/0,,id=96739,00.html.

Corporate foreign tax credit.A company’s structure — S corporation, C corporation, limited liabilitycompany, and so on — may affect its tax obligations differently indifferent countries.

In 2000, U.S. firms paid $48 billion intaxes to other countries. Corporate foreign tax credits allowqualifying companies to avoid paying taxes on the same revenue at homeand abroad. But S corporations, which individuals own, may have limitedability to take advantage of corporate foreign tax credits.

Taxexperts say that companies can minimize taxes under many differentcorporate structures but need to know what that structure is in advanceand plan accordingly.

Value-added tax. Unlike the UnitedStates, many countries tax a product sale at several steps during themanufacturing, distribution and purchase of an item. This value-addedtax (VAT) is on the books in all 25 European Union (EU) nations.

Here’show the VAT works: When selling a product for 100 euros in theNetherlands, a company must charge the buyer 119 euros for the product,because that nation’s VAT is 19 percent. The company must remit 19euros to the government, but it can offset that liability with previousVAT payments it has made.

The VAT, also in place in Australia,Canada, Japan, Mexico, New Zealand and Singapore under different names,requires detailed record-keeping and preparation before the first sale.

TheEU exempts some products, such as medical supplies, from the VAT andtaxes others, such as food items and baby products, at a reduced rate.The VAT rate and classification of goods vary by country, so it’simportant to do the necessary prep work.

Without preparation, acompany can take a direct hit from the VAT — not many companies couldtolerate a 19 percent reduction in gross profit.

"Do it before you start," says Erik Scheer, an attorney and VAT expert with Baker & McKenzie in Amsterdam.

It’salso important to note that the VAT is based on the percentage ofsales, not the percentage of profit. In short, said Scheer, "it must bepaid."

Tariffs. It may be a global economy, but thatdoesn’t mean countries have removed all trade barriers. Most countriesstill penalize selected imports. Without proper planning, companies maysee these tariffs cut into profit margins.

When exporting goodsinto the EU, an important first step is getting a government to rule onhow it will classify a product, a process called binding tariffinformation (BTI). The advantage to getting a BTI before beginning toexport is risk avoidance. The U.S. company knows how foreignjurisdictions will treat its product, so the company can planaccordingly. Some high-tech items are exempt from tariffs; securing aBTI early will ease the mind of the business owner.

It’s alsoimportant to know a product’s customs valuation. In most cases, thecustoms valuation is the product’s selling price. But somejurisdictions consider the valuation to be the lower "first sale forexport" that the exporter paid for the product.

How does the"first sale for export" save money? Although a firm’s product may sellfor 100 euros in the Netherlands, perhaps another U.S. company sold theproduct for the equivalent of 80 euros. If that’s the case, it mayqualify for a tariff based on the "first sale for export," therebysaving money.

Finally, if a U.S. business manufactures a productin a less developed nation such as Vietnam or Bangladesh and importsthe product to Europe, customs may waive the tariff. The EU wants toencourage greater growth in such countries, so it offers preferentialtariffs on some products from some countries.

However, it’sincumbent on each company to ensure government officials in Vietnam,Bangladesh and elsewhere complete the paperwork correctly. If not, thebusiness owner may have to pay those tariffs after all.

What to do?The world is full of business opportunities. But those opportunitiesalso present some risk. The best way to avoid unnecessary taxes andlegal hassles is to plan ahead.

Martin Regalia, chief economistfor the U.S. Chamber of Commerce, believes U.S. business owners shouldseek advice before embarking on international expansions.

"It’snot something for a neophyte to get into," Regalia says. "When doingbusiness internationally, you have tax systems that weren’t designed towork together."