A few days ago I attended a training seminar on how to advise small businesses about choosing an appropriate legal form to run their business. This included a review of the tax considerations that should be factored into a decision to operate using one form over another.
The presentation covered the various forms of business structures available in the U.S. that are often used by small businesses in many industries. By far the most common types that were used were S corporations, limited liability companies and limited partnerships.
The speaker who covered the tax issues discussed the basic considerations that affect small businesses, which included the potential exposure to double taxation where both shareholder and corporate entity may become subject to tax and the pass-through of tax attributes depending on which entity was chosen.
However, what was noticeably missing from the discussion of the tax issues were the international tax concerns that arise when operating a small business, especially a small business with an online presence. Those issues include the following:
- Determination of Status: Each jurisdiction defines small business differently. There is no standard international definition. If you are actively seeking to take advantage of being classified as a small business for purposes of obtaining a loan, take advantage of a preferred tax rate or maintain eligibility for certain government sponsored programs these distinction may be vital to where you ultimately decide to operate your business. For example, the United States uses industry codes to determine whether a certain type of business is considered small. Canada, on the other hand, defines small sized businesses based on either or both revenue and number of employees. The UK makes the determination based on the balance sheet, number of employees and revenues.
- Compliance: The United States is one of the few jurisdictions that have a worldwide system of taxation. Simply, this means that if you are a citizen or resident of the US, you are required to file a tax return and claim all income regardless of where that income was earned. The foreign tax credit regime attempts to eliminate the double tax effect that this creates. However, outside of basic tax reporting obligations the US also requires the reporting of assets owned in foreign jurisdictions as well. The reporting requirements are referred to as “FBAR”, which stands for Foreign Bank and Financial Accounts; and “FACTA”, an acronym for Foreign Account Tax Compliance. An FBAR is required where a US taxpayer has signing authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account where a certain dollar value threshold is met. FACTA requires taxpayers with specified foreign financial assets that exceed certain thresholds to report those assets. Penalties for failing to comply can be very hefty.
- Withholding Tax Obligations: The US has an extensive tax treaty network. Tax treaties serve many purposes. One such purpose is reducing withholding tax obligations for certain activities carried on in a country with a tax treaty with the US. If no treaty is in place, or if the activity that the business is engaged in is not covered by the treaty, then a portion of any monies received as payment to a non-resident of that jurisdiction may be withheld to satisfy local tax obligations. Factoring this into cash flow analysis is essential to forecasting your businesses access to its revenue.
- Transfer Pricing: According to the IRS website, these rules basically govern “prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, or intangibles”. The goal is to ensure that these transactions yield results that are consistent with the results that would have been realized if uncontrolled/unrelated taxpayers had engaged in the same transaction under the same circumstances. This can be a very tricky area to navigate. Where goods are services are being offered between related/controlled businesses in different geographical jurisdictions it may be worthwhile obtain professional advice to ward against any of these types of audits. An adjustment penalty may otherwise apply.
July 2, 2012