Expanding into the US: Tax and Accounting

This article explores common tax and accounting challenges that non-US businesses encounter when entering the US market. For many businesses, especially in the tech sector, expanding into the US can lead to rapid growth and significant opportunities. It's crucial to establish a solid framework from the outset to avoid costly mistakes and excessive management efforts.

Do You Need a US Subsidiary?

One of the first considerations when expanding into the US is whether you need to establish a subsidiary. If you're merely selling to US customers with limited or no physical presence, a subsidiary may not be necessary. Often, the need for a subsidiary arises when hiring local employees. Even without a subsidiary, you may still have sales or state corporate income tax obligations. Additionally, having a physical presence or someone concluding contracts on your behalf in the US likely creates a taxable presence for federal corporate income tax purposes.

Once You Have Decided to Set Up a US Subsidiary

The creation of a US subsidiary will immediately bring you within the US tax net. The matters to be addressed can be divided between routine (registrations, annual compliance, and annual returns) and planning/advisory areas. Key areas include transfer pricing, state taxes (including Sales and Use taxes), and global mobility.

Choice of Entity

The most common form of entity established by non-US parent companies is the Delaware incorporated C corporation. Note that the state of incorporation is based on corporate law considerations, not tax. Alternatives to the C corporation include a Limited Liability Company (LLC) or, rarely, an S corporation.

Obtaining an Employer Identification Number (EIN)

Once the company has been formed, you must register with federal tax authorities by applying for an EIN. The process involves fax machines and special phone lines. Obtaining an EIN typically takes a couple of weeks, during which you cannot open a bank account or set up payroll.

Establishing Your Operating Model

Decide whether your US company will contract with customers or provide support services to the parent company. This decision impacts tax positioning, particularly regarding transfer pricing. Establishing the correct operating model upfront can prevent tax inquiries and ensure an efficient tax strategy for international expansion.

Key Considerations:

• Will the US act as a full-risk distributor or a limited-risk distributor?
• Should it pay royalties back to the parent company, or fix remuneration another way?
• Is the US entity acting as an agent for the parent company?

Supporting this operating model involves a benchmarking exercise and legally binding intercompany agreements. For smaller companies, detailed documentation may be deferred.

State and Local Taxes

The US tax system includes federal, state, and local taxes. State income taxes, typically 6%-12%, are separate from federal taxes and not covered by double tax treaties. Sales taxes differ from VAT and depend on state-specific rules. States may impose franchise taxes or property taxes, requiring companies to file numerous annual returns.

Sales Tax Nexus

Sales taxes are due if you have physical or economic nexus in a state, determined by sales volume. Ensure compliance to avoid costly mistakes during audits.

Payroll Taxes and Stock Options

Employing US-based staff requires payroll services and compliance with withholding tax obligations. Offering stock options necessitates careful valuation to avoid tax issues under the IRS’s Section 409A rules.

Global Mobility

For UK companies sending employees to the US, consider the tax residence status, reporting obligations, and company policies on compensating tax differences. Both UK and US regulations may require payroll and income tax filings for short-term assignments.

Inversions (Delaware Flip)

For access to US investors, companies may establish a US entity above their existing UK company. Known as a "Delaware Flip," this restructuring requires careful planning to avoid capital gains tax, stamp duty land tax, and other issues. Securing HMRC clearances can prevent future complications.

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Conclusion

Expanding into the US offers immense opportunities but requires careful tax and accounting planning. The complexities of federal and state systems can lead to costly mistakes if not addressed early. Working with experienced advisers ensures a smooth transition and successful international growth.

About the Authors

Malcolm Joy leads Frazier & Deeter’s UK practice and Transfer Pricing team.
Mike Whitacre is a Tax Partner at Frazier & Deeter, based in Atlanta, GA, specializing in multinational organizations.