The U.S. energy and corporate market is increasingly opening up to European clean tech companies as they move to a decentralized energy system and focus on greater resilience to climate change.
The federal tax cuts that were signed into law in December 2017 are impacting foreign companies’ tax exposure when they invest and pursue cross-border projects in the United States, according to Andrew Oppenheimer, a senior associate at law firm Hodgson Russ, which advises foreign companies entering the U.S. market. Oppenheimer spoke on a recent CleanTechIQ webinar, Implications of New U.S. Tax Law in Cross-Border Transactions.
The new tax law reduces federal taxes for corporations operating in the U.S. from 35% to 21%, and that steep cut is leading to a lot of interest in setting up U.S. companies from foreign companies that face higher tax rates in their respective countries, Oppenheimer says. In particular, Hodgson Russ is seeing a lot of interest from companies in Canada, the UK, France, Germany and Belgium.
The new tax law also includes a special deduction for “foreign derived intangible income,” including royalty payments made to companies that license their IP to U.S. companies, which brings the tax rate on that income to just 13%, according to Oppenheimer. This deduction is intended to make the U.S. a more attractive market for companies to develop intellectual property, he points out.
Why Form a U.S. Entity?
As a foreign company’s U.S. sales grow meaningfully, or when the company decides to begin manufacturing its products in the U.S., the non-resident company must decide on how to structure its U.S. operation, Oppenheimer says.
For any foreign jurisdiction that has a U.S. tax treaty, a non-resident company’s business profits are only subject to U.S. federal income tax if the company has a so-called “permanent establishment” in the U.S.
A permanent establishment is created when there is a fixed place of business in the U.S. and employees sent to the U.S. can undertake certain duties, such as entering into contracts in the name of the non-resident company.
Forming a separate U.S. entity has several benefits, according to Oppenheimer: it insulates the non-US company from issues arising in the U.S.; it makes it easier to get U.S. bank financing; and it gives the parent company an ability to actively manage its tax exposure related to its cross-border activity.
As for the type of U.S. entity, Oppenheimer strongly recommends that foreign companies set up a C corporation due to its tax advantages and because it allows the non-U.S. parent company to avoid filing a federal tax return.
He advises foreign companies to stay away from what are known as “flow-through entities” such as S-corporations and limited liability companies (LLCs). That’s because, in a flow-through entity, taxes are imposed at the parent or owner level, which means the non-resident company will need to file a non-resident U.S. tax return.
Additionally, flow-through entities cannot have a foreign investor. And tax withholdings are imposed on the distributions made from the income that an LLC generates for the parent company. This is different from a C-corporation, where tax withholding is only imposed when a dividend is authorized by its board and paid to shareholders.
Other important tax-related issues that foreign companies need to be aware of when taking distributions from their U.S. subsidiaries include the accumulated earnings tax, personal holding company tax and repatriating funds from the U.S. to the parent company without withholding tax, Oppenheimer says.
To view the entire webinar and download the slides, which provides insight on all key tax issues that foreign companies need to consider when entering the U.S. market, click here.