Earlier this month, I had the benefit of traveling to three of North America’s largest cities in one three-day segment. I visited New York City, Montreal and Washington, D.C. Granted, I spent more time in airports and hotels that actually seeing the cities I was in, as is usually the case with business travel. However, I was able to observe the surroundings, view some news reporting and read the newspapers.
I compared what I saw and heard with previous visits over the past 18 months. There is a scent of optimism in the air and a level of confidence that the economy is in a better state than one year ago. However, there is still some uncertainty regarding whether we have fully turned the corner. The economic crisis in Greece along with some other European countries in need of assistance and the impact of the oil spill in the Gulf of Mexico are weighing down the optimism.
Transactional activity has started up again. A vibrant merger and acquisition market is generally a good sign that there is confidence by acquirers and their investors that the tide has changed for the better. More deals are in process and more are likely in the deal pipeline. Interest rates remain low, which has assisted in keeping asset values from falling further. The test will be whether asset values will be maintained when rates rise, especially in the fragile housing market.
In recent conversations with business leaders and other advisers, I sense there is a desire for more certainty in Washington with regard to fiscal and, in particular, tax policy. It is difficult for business leaders to make business decisions when certain government policies, including tax and trade policy, are not fully known. Many in business are still digesting the bailouts of the automakers, the stimulus spending, the health care reform and other announced proposed reforms. Businesses are still attempting to assess what the impact of these changes means for their business, customers, suppliers and employees.
The impact of the recent economic downturn has not been confined to the United States or North America. We, after all, do live in a global economy. To some extent, when the U.S. sneezes, many countries across the globe catch a cold. As with any infection, it takes time to heal.
As I mentioned, Montreal was included in my recent travels. Canada remains one of our largest trading partners. The trade activity between Michigan and Canada is large, due in part to the large manufacturing base in Michigan and Ontario. Doing business in Canada is a natural for many U.S. businesses seeking a new market. With a common border, common living standards and a strong currency as measured against the U.S. dollar, there is a comfort level among many businesses in venturing into this international market. In addition, at the end of 2008, the U.S. and Canada finalized the Fifth Protocol to their Tax Treaty between the two countries. The 2008 discussion (during the political campaigns) on whether a withdrawal from NAFTA should be considered has subsided and may not have any further momentum.
Many businesses have found or will find the necessity to go international as part of their business strategy. Many Michigan-based businesses often initially cross the border to Ontario in their process of going international with products and services. The decision requires planning for various business risks as well as consideration of tax issues. Tax issues can vary from sales or value-added taxes (known as the goods and services tax, or GST, in Canada), customs and tariffs, employer-related taxes and corporate income taxes. Recent changes in the tax treaty have made it more likely that companies and employees of those companies may trigger a taxable presence in Canada.
Appreciation of the U.S. international tax considerations as well as the international taxation issues are paramount in engaging in cross-border commerce. This includes services as well as the sale of products. With the growing service component of the economy, there are specific issues to consider with expansion of business activities to Canada.
For example, Canadian companies are required to withhold (unless a treaty waiver is granted) 15 percent out of any payments to U.S.-based service providers for conducting activities in Canada. In addition, provincial withholding taxes may apply. Quebec, for example, has a provincial withholding (in addition to any federal withholding taxes) of 8 percent on payments made to service providers that are non-residents of Canada.
Employer level withholding and payroll taxes may also be required in addition to any corporate or business level income taxes. Even if a treaty exemption reduces or eliminates tax liability, it is likely a treaty-based income tax return may be required by the business and any of its employees that conduct activities in Canada.
The U.S. planning and the interaction of Canadian income taxes, U.S. income taxes and the U.S. foreign tax credit rules can complicate even the most basic business structures and business activities. Terms such as check-the-box, entity selection, business registration, etc., all come up in conversations with advisers. Issues regarding capitalization of a foreign entity with debt or equity, transfer pricing issues and repatriation strategies all impact various aspects of any structuring of the business in a foreign country. In addition, local accounting standards may differ from U.S. accounting principles and standards, which may impact the financial reporting of the activities.
Once all the details are worked out, the identification of the specific compliance (annual returns and disclosures) needs to be performed. The U.S. has very specific reporting for foreign investment activities. The filings that may be required include such items as Forms 926, 5471, 8858, 8865 (among many other possible filings). Foreign countries also have their own disclosure and reporting requirements regarding foreign investment and activities in their respective countries. Recent U.S. legislation has expanded penalties for incomplete or non-filing of the above forms and other required filings for activities and investments conducted outside the U.S.
In addition, the recent HIRE Act that included jobs creation incentives included a provision to change the statute of limitations period for any tax return that does not include the required disclosures and attachments mentioned above. Under the recent change in law, the statute of limitations for all the items of income and deduction, tax liability and credits, etc., does not begin to run until the required international filings are included within annual tax returns. This one-two punch of a penalty for non-filing and the non-running of the tax return statute of limitations are powerful reminders that taxpayers must consider in completing their annual U.S. tax filings
International business activity is an attractive strategy for many U.S. businesses. Much care and deliberation is required to provide the needed attention to the details in order to avoid some of the tax, legal and other issues and traps that international activity may create.
William E. Roth III is a tax partner with BDO Seidman LLP. The views expressed above are those of the author and are not necessarily those of BDO Seidman LLP The comments expressed above are general in nature and not to be considered as specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult with their professional advisers before acting on any items discussed herein.