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August 31, 2012

Tax Consequences of Locating an Affiliate Business

The paper lays emphasis on the tax implications and consequences on an affiliate business in a foreign country. The impact of taxes by the parent companies on affiliate industries have been a great concern for the affiliate businesses operating in foreign territories. The indirect taxes burden significantly exceeds the foreign income tax obligation of foreign affiliates. The higher corporate income taxes rates had depressed capital/labor ratios and profit rates of the foreign affiliates as compared to indirect tax rates. 

The establishment of an affiliate business in a foreign country is adhered to various tax implications by the local legislation and country in which it operates. The multinational investment usually occurs when a company expects that locating manufacture or production abroad will allow it to earn a higher return from its investment through proper tax planning than affiliate business is a favorite choice for the employer. Investments by multinational corporations are generally subject to tax in the foreign countries in which the income is earned, but also typically in the home country in which the multinational is headquartered or otherwise deemed to be resident for tax purposes. International tax rules and the tax laws of other countries have the potential to influence a wide range of corporate and individual behavior, including, most directly, the location and scope of international business activity Numbers of tax consequences are considered when allocating affiliate business in a foreign country, some of which are important for in depth analysis.

  1. Location of the Affiliate Business:
Location is more than just choosing a building and a perfect location can double the returns on the investment but it should also consider the tax consequences and implication by the local and international legislative on the affiliates.
  • State: It differs which state or country you chose to start your business and what will be the tax implication on the parent and the affiliate altogether. For e.g. In U.S a foreign affiliate of an American employer is any foreign entity in which the American employer has at least a 10% interest, directly or through one or more entities. For a corporation, the 10% interest must be in its voting stock. For any other entity, the 10% interest must be in its profits.
  • Unfavorable tax regulations: While selecting the location, the taxes you pay in a foreign country should reduce the taxes firm pay in the home country as much as possible. As the legal structure for the business will likely affect the amount the firm owes.
  • Understanding the local taxes: Local taxes often apply to the property owned rental income and affiliate business that have a direct investment in that country. For e.g. UK companies get a double tax relief on income and capital gain when the parent company has a direct or indirect holding in the affiliate and is broadly equivalent to the UK tax the company is adhered to pay.

  1. Organizational Structure of the Affiliate:
The next important factor is determining the organizational structure of the affiliate business. It can be a Subsidiary, Branch or a Franchise which a foreign direct investment.
Subsidiary is a company whose voting stock is more than 50% of the owned company or a company for which a majority of the voting stock is owned by a holding company. The foreign U.S subsidiary is by and large independent of the parent company as it has its own employees and premises to conduct business in that country.
Branch overseas is an extension of the firm’s trade and usually the branch profits will be assessed for the corporation tax overseas depending on the local regulations.

Tax treatments
A foreign U.S subsidiary is not subjected to the current U.S tax on its foreign income unless that income is in the range of ‘ Subpart F income’ which explains all passive investment income and income from the foreign corporation derived from favorable pricing such as transfer pricing which relates to the affiliated U.S entities or persons.
The foreign subsidiary is the resident of the country in which it operates and is licensed to conduct business in that country. If the foreign country imposes any income, employment, corporation or value added taxes than the foreign subsidiary is strictly subject to those taxes just the same as a local firm.
The international tax literature suggests that U.S personal tax rates are lower as compared to significant higher corporation taxes for foreign subsidiaries. For non-corporate owners of foreign corporations, it is an advantage to elect for 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.
The U.S foreign branch imposes branch profits tax to imitate the dividend withholding tax. The branch profit tax is imposed at the time when profits are remitted or deemed to be remitted outside the U.S. Generally the foreign U.S branch is taxed only on business income if it is effectively connected with the U.S business and the rate to be taxed is the same as the resident corporation. The foreign branch will be subjected to withholding at 30% on dividends, interests, royalties and other income. The branch interest tax is levied on interest paid  by a branch at 30% unless the interest would be exempt by treaty from withholding tax by the parent U.S corporation.
Another important tax implication is the foreign tax relief that allows tax credit for foreign income taxes paid by U.S corporations. The credit is restricted to allowance of U.S tax imposed on foreign operation portion of the taxable income. The relaxation is deemed to occur only if the tax years begin before or after 1 January 2007. Separate limitations are applied to various categories of income, financial services, shipping income, dividend income derived from foreign U.S based branches or subsidiaries.
The choice a multinational corporation has between a foreign branches or local subsidiary is very important in relation to tax implications. For e.g. in U.S tax laws do not permit a foreign corporation or foreign branches to be consolidated for tax purposes but for reporting only. This might raise an important factor if the foreign subsidiary has been in losses for several years after the start up.
Another factor is the potential benefit of tax deferral of home country on foreign income from a fully incorporated foreign subsidiary against the total burden of paying foreign corporate income taxes and withholding taxes once the income is distributed to parent corporation. Therefore the foreign branch will pay taxes to the parent company but no with holding taxes when the after tax income is distributed to the parent.

Tax heaven subsidiaries
Tax haven subsidiaries of financial offshore centers for incorporating U.S affiliate business are one of the major choices for the corporation with regard for tax relief. For tax haven subsidiaries there is low tax on foreign investments by the resident corporations and low dividend withholding tax on dividends paid to the parent firm. The most attractive is the stable currency to permit easy conversion of funds in and out of the local currency and a stable government that encourages establishment of foreign owned subsidiaries within its borders.

The tax consequence for locating a foreign branch or subsidiary is a vital factor when deciding over a choice to expand business overseas. Other than tax, non tax factors should also be considered such as the political and local legislative requirements, managerial incentives and public image of the parent company for establishment of business affiliate overseas. The tax advantage and disadvantages over the foreign business should carefully be understood and analyses by the help of local or expert tax planning of that country to maximum defer the tax liability and heavy tax payments through corporation tax on overseas affiliates.


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