Avoiding Double Tax on Overseas Profits – July 09, 2014 by Ray Polantz

Doing business internationally is practically a necessity to survive in today’s competitive business environment. Many companies find that setting up a separate legal entity in a foreign jurisdiction is the best way to conduct business there. Operating through a foreign subsidiary, however, presents many challenges, including the potential for double taxation of profits.

Generally, profits earned in foreign subsidiary corporations can be subject to two layers of tax:

  • tax in the foreign jurisdiction; and
  • U.S. tax when profits are repatriated, often in the form of a dividend.

At times this potential double taxation is mitigated by the U.S. tax system’s foreign tax credit regime, which allows a dollar-for-dollar reduction of U.S. tax for foreign income taxes paid, subject to certain limitations. However, not all U.S. owners are eligible to claim foreign tax credits for the income taxes paid by a foreign subsidiary corporation.

Thankfully, there are options for those who plan upfront. Taxpayers may benefit from making a “check-the-box” election that treats the foreign subsidiary as a disregarded entity for U.S. tax purposes. By making this election, taxpayers forfeit U.S. tax deferral on foreign profits. However, the election will make the underlying foreign income taxes eligible to be claimed as a credit, which may allow taxpayers to mitigate double taxation.

If you are considering forming a foreign entity to conduct business overseas, be sure to properly plan upfront to minimize worldwide taxes.

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This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.