You did it! You started your business and got it off the ground. Now you’re hoping for success in your market and maybe even expansion across state lines. But are you thinking even bigger than that? Are you ready for your business to take on the world?
Many U.S. companies have expanded into the global market and crossed international borders. With this leap comes a new set of tax considerations sure to brighten your day. Welcome to the world of international tax.
To begin your international tax journey, let’s start with the ways to deal with international tax:
- Profits can be taxed immediately in the U.S.
- Profits can be taxed when repatriated (otherwise known as coming back to the original place or location), depending on the structure you choose. This is more commonly known as the deferral system.
Are you thinking it sounds pretty straightforward? Well, where the IRS and international tax law are involved, we promise you it’s not. Let’s have a conversation about intangible property.
Intangible property (IP) is something of value that cannot be touched or held, such as a copyright or a trademark. In this particular context, it often refers to something created by a business such as technology know-how, process or trade secrets. When this is developed in the U.S. and then used outside of the country by a related party, the IRS requires the company be compensated for the IP use. Yes, the IRS even has rules about taxation on items you can’t even see.
This is where advanced planning comes in handy. Planning ahead minimizes your tax burden over the long term. You do this through something called IP migration. IP migration occurs when a U.S. company transfers the right to use their IP outside of the U.S. to a foreign subsidiary. As a result, the income (and subsequent taxation) will accrue to your foreign sidekick, not to your U.S. based company. Since corporate taxation in other parts of the world is typically lower than the U.S., you’re looking at increased cash flow for your business.
IP migration can work particularly well for startups. Why? Well, you have to pay tax on the initial transfer of the IP, but start-up companies often have net operating losses to offset the income tax. This initial tax is often less than the payments that would otherwise have to be made to the U.S. over the useful life of the IP. Also, the younger your IP, the lower the estimated tax value. This is because it hasn’t had the opportunity to prove itself valuable in other markets yet.
Of course it’s not all sunshine and rainbows. The transfer of an IP comes with its own set of costs, including legal, accounting, valuation or transfer pricing, and having substance in a foreign jurisdiction to manage the IP usage and development. It is also important for the U.S. and foreign subsidiary to enter into a cost sharing agreement in regards to the cost and rights to use the further development of the IP. Otherwise, there may be new IP created in one country that will need a subsequent transfer if used in the other. So you have to look at the pros and cons and see what’s best for your business. Hey, no one said thinking globally was easy.
A version of this article first appeared on Eide Bailly’s International Tax site.