WHILE cross-border business offers appealing opportunities, it’s important to be mindful of the flip side of the coin you could potentially make. What percentage of that coin does the country you’re venturing into expect in return?
Economic globalisation has long posed challenges to both tax authorities and taxpayers.
Tax authorities of every country are faced with the challenge of creating and adapting laws to the modern economy while balancing the need to raise revenue and the desire to attract business.
These conflicting motivations often result in more complex systems of taxation which requires taxpayers to engage in more careful tax planning.
The US, for example, has developed a robust and complex system of laws to address the taxation of cross-border transactions. The far-reaching nature of the US tax system imposes tax obligations on businesses and individuals around the world, particularly in Asia. There are many Asian businesses with financial connections to the US because of the trade of goods and services between Asia and North America, as well as financial investments into the US economy and market.
In 2022, US goods and services trade with ASEAN totalled an estimated US$520.3 billion and trade with China totalled an estimated US$758.4 billion. It is critical for Asian businesses with financial connections to the US to understand their US tax and reporting obligations. Failing to do so can lead to costly mistakes.
Reporting Obligations for Asian Businesses
The US tax system is broad and far reaching.
Even seemingly insignificant connections to the US may create US tax issues.
Most commonly, an Asian business will be subject to US tax when it is operating a trade or business in the US. This is true whether it is operating directly or through a US subsidiary. An Asian business may also be subject to US tax if it earns income through investments in US assets such as US stock or real estate.
A less obvious reason why Asian businesses might be subject to US tax laws is if the beneficial owners of the business hold a green card or have US citizenship.
Additionally, Asian business owners should plan for the US estate tax if they hold US assets or if any of their beneficiaries have US status or plan to move to the US.
Asian businesses operating in the US may be subject to a variety of US taxes depending on the type of operations and the structure of the business. The most common taxes that may be applicable include the corporate income tax (21%), branch profits tax (up to 30%), withholding taxes (up to 30%), and excise taxes (rate is dependent on type of goods involved).
The effective tax rate of an Asian business with US operations can also vary depending on the operating structure, applicability of deductions and tax treaty benefits.
Furthermore, the US offers tax incentives for businesses that choose to run operations through the US without any physical ties.
Beyond Tax
For an Asian business with US operations, paying taxes is only one piece of the puzzle.
Another aspect of US tax is information reporting. The reports are used by the Internal Revenue Service (IRS) to monitor taxpayers and prevent financial crimes.
There are many reasons why a taxpayer may need to file an information reporting form and there are several different forms that may need to be filed.
The most common reporting form for Asian businesses with US operations is Form 5472 which is used to report foreign ownership of US corporations and is also used to report when a foreign business is engaged in a US trade or business through a direct owned limited liability company (LLC).
Even though these information reporting forms do not impact tax due, they can impact your bottom line if you fail to file them.
Failure to file the information reports can lead to penalties of US$10,000-$25,000 per form, per year.
Amounts can quickly add up when the forms are missed for multiple years and these penalties can be increased if the non-compliance was due to willful conduct. Criminal penalties can also be imposed in some circumstances.
Relying on competent US tax counsel is valuable for avoiding information return penalties. To illustrate the importance of US international tax compliance, I will share recent challenges faced by some of our clients. Client names and certain details are left out to protect client confidentiality.
One of our clients had an accountant who believed there would be no penalty for the late filing of international reporting forms because the corporation did not owe taxes. This client operated in the US through a complex structure that required two Forms 5471 and two Forms 5472. The IRS assessed a penalty of US$70,000 because the accountant filed the returns one month late. We disputed the penalties on the basis that the client should not be penalised for the error of the accountant and were successful in completely abating the penalty.
Just as important as knowing when you need to file is knowing when you do not need to file. We represented a client who was advised that they needed to file a US information reporting form. The deadline for the form had passed and their accountant filed the form late. The client was assessed a penalty. When the client engaged our services, we determined that the form did not actually need to be filed and helped the client dispute the penalty with the IRS.
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Sources Of Information
Often, Asian business owners wonder how the US can discover the nature of their activities and enforce the filing requirements discussed above. While the IRS does not disclose all details of their investigation techniques, much of the information the IRS obtains for enforcement purposes is obtained through reports by financial institutions subjected to the Foreign Account Tax Compliance Act (FATCA).
FATCA is the US equivalent of the Common Reporting Standard (CRS).
Additionally, the newly minted Corporate Transparency Act (CTA) will serve as an additional source of information for the IRS.
Under FATCA, financial institutions around the world are required to obtain and validate client tax information. The information gathered by financial institutions is then used by tax authorities to prevent tax evasion and other financial crimes.
The CTA, enacted in 2021, further increases the enforcement abilities of the IRS by requiring the beneficial owners of specific entities operating in the US market to be identified. Lastly, the IRS also enforces many tax reports on the US institution, which means if ownership of stocks or other assets is to be transferred, the US financial institution may request to see proper tax reporting before completing the transaction.
The IRS is increasing its enforcement abilities through the additional US$80 billion of funding it received in the 2022 Inflation Reduction Act. With the additional budget allocation, the IRS plans to hire over 20,000 new staff over the next two years.
With increased transparency and additional IRS resources, it is essential that Asian businesses with financial ties to the US consult with qualified US tax professionals to ensure compliance. Asian businesses should also maintain accurate and up-to-date financial records to facilitate tax compliance and support their tax positions. Additionally, business owners must stay informed about changes in US tax laws and international transparency initiatives.
The views expressed in this article are those of the author, Jared Garfield, Associate Attorney at Hone Maxwell LLP Singapore.
