The consequences of doing business in a country with which the U.S. has a tax treaty can be much different than those encountered when dealing with a non-treaty country. It’s important to understand the basic differences of each.
The United States has a number of bilateral tax treaties with its various trading partners meant to facilitate economic activity and investment between countries. For tax purposes, the treaties often eliminate double taxation and provide certainty to taxpayers where tax jurisdictions overlap.
Most tax treaties provide that U.S. taxpayers must have a “permanent establishment” (PE) in the foreign jurisdiction to become subject to that country’s income taxes. There are a number of activities that can create a PE. A classic example is an office building or other fixed place of business. However, other activities can create a deemed PE. For example, in Canada, a U.S. person providing services for an aggregate of 183 days or more in any 12-month period will create a deemed PE. In many countries, a sales person with the ability to approve orders will create a deemed PE.
So what happens if you create a PE in a “tax treaty” country? You will likely create an income tax filing requirement and be subject to that jurisdiction’s income taxes. However, these taxes will likely be eligible to be claimed as a foreign tax credit — a dollar-for-dollar reduction of U.S. tax, subject to certain limits. Proper planning can either help taxpayers avoid unintentional PEs or help ensure that any resulting foreign tax credits are maximized.
In general, as you might expect, doing business in a non-treaty country provides challenges. The key thing to know when doing business in a country in which the U.S. does not maintain a tax treaty is that the threshold of when that country imposes income taxes on your business will be very low, which can cause unsuspecting taxpayers to be subjected to foreign income taxes. Rather than being held to the higher PE threshold, U.S. taxpayers may become subject to foreign country taxation if they are deemed to be doing business in that country — even for seemingly low-level activities. For example, depending on the local country laws, taxpayers could be considered to be doing business if they are merely soliciting sales. Some notable examples of countries for which the U.S. does not currently have an income tax treaty include Brazil, Argentina, Chile, Vietnam and Singapore.
Your business will take you where you need to be, but, when at all possible, doing business in a country in which the U.S. has a tax treaty will afford your business the most certainty from a tax perspective.
Contact Ray Polantz at rpolantz@cohencpa.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.