This past winter, I had the opportunity to engage in dialogue with a contributor to Forbesand with CFO.com on international business tax issues. The discussions were a bit different but were focused on the issues and considerations with conducting business in a global marketplace.
Cross-border business activity continues to increase each year, and more West Michigan companies are participating.
Expanding into international markets can be done in many ways. Often, it starts by exporting products to nearby markets such as Canada and Mexico. Or, it can be importing product from Asia or Europe for sale in the U.S. Those situations can present issues with customs and duties, value-added taxes, language issues with packaging, and other U.S. and foreign regulatory issues. So, a transaction that seems to be relatively simple at first becomes complex in very short fashion.
The next step for a business may be sending employees or representatives to conduct marketing activities and solicit sales. These activities can trigger local country tax issues such as permanent establishment, employer and employee payroll issues, and the need to understand local tax law, as well as any tax treaty provisions that may apply to the activity.
As an example, Canada has stepped up its reporting requirements for employee and company activity, especially by U.S. companies and their U.S. employees in Canada. I will repeat two sections in the Canadian tax law that my colleagues in Canada often mention in these situations: Regulation 102 and Regulation 105. These sections are not necessarily four-letter words, though some may think they are. They are provisions in Canadian tax law that may impact the taxation of both a company doing business in Canada and its employees.
Other countries may have similar requirements. In addition, U.S. tax compliance reporting requirements can also complicate the situation. Thus, any international activity by a business has both U.S. and foreign tax reporting to consider.
Detection of activities by local tax authorities has increased in recent years. The ability for tracking and detection is obvious. Governments and others have access to a fair amount of data. Just think for a moment about what Homeland Security, the National Security Agency, mobile phone providers, credit card companies and others know about company and employee travels, communications and other activities. Social media pages and websites also provide easily accessible information.
Often businesses decide to take the leap and acquire a business in a foreign country or decide to expand internally to another country. This step often involves a major financial investment. Such investments are often made in a rather short time horizon and not in a deliberate, strategic fashion. The result often increases the financial risk of a business as now it faces political risk, currency risk and sovereign risk in those markets.
These risks are out of the control of a business. Just take a look at the recent turmoil in the Ukraine with Russia and the tension this has caused with the trading partners of these countries (mainly the EU and U.S.). Such disruptions can impact foreign investment decisions and the financial results from those decisions.
The formation of new business entities in other countries can often take extended periods of time compared to the speed of forming a business entity in the U.S. What happens in hours here can take days, weeks or months elsewhere. In addition, local country regulatory requirements may require certain approvals and compliance with local financial reporting or statutory audit requirements as well as different financial reporting standards. Financial statements based on U.S. GAAP standards may not be acceptable in the local jurisdiction. Hiring and firing employees is different than in the U.S. And, lastly, there are language and cultural issues to deal with.
Protection of intellectual property (patents, knowhow, trade secrets and processes) is another concern of doing business in international markets. Both domestic and foreign legal counsel need to be involved in any discussion on the use and exploitation of any intellectual property outside the U.S. Such property may be of significant value to the business, so all necessary steps should be taken to use all legal processes to maintain and protect the intellectual property.
In my experiences over the years, businesses with the most success going international are those that have taken the time to made deliberate and strategic decisions regarding their business and growth opportunities. Like the fable of the tortoise and the hare, they have followed a course of “slow and steady wins the race.”
It is important for these businesses to utilize advisers who have formal and informal networks of professionals they have worked with in the past. My firm benefits from being part of a worldwide network of member firms in nearly 150 countries. That network allows clients to access the resources and connections of those firms. Many law firms and accounting firms have similar relationships and networks that can be an invaluable asset.
Businesses often put emphasis on tax planning as the most important item. Tax planning can enhance business expansion into new markets and opportunities, but it isn’t the be-all and end-all to the planning. Business decisions need to be made on strategic, commercial and business reasons, and tax planning can enhance the result of that planning. For example, if a company decides to export products to other countries, the use of an IC-DISC (which we have discussed in the past) for those activities may enhance the profits resulting from the export activity.
Many West Michigan companies have taken the plunge into expanding internationally. There are many success stories in our area, as well as some great stories that offer learning experiences of what worked and didn’t work. Take advantage of that knowledge and history.
Bill Roth is a tax partner with the local office of accounting firm BDO USA. The views expressed are those of the author and not necessarily of BDO USA. The comments are general in nature and not to be considered specific tax or accounting advice. Readers are advised to consult their professional advisers before acting on any items discussed.