With the pace and amount of direct investment in the United States increasing dramatically, fueled by such incentives like the EB-5 and EB-6 Visa programs, proper structuring remains a critical but frequently overlooked aspect to such investment. Tax-efficient structuring can, however, enhance returns and avoid costly restructuring down the road.
Effective tax planning for direct investment in the U.S. involves consideration of the nature of the planned activity, selection and ownership of the appropriate business entity, effective financing of the venture, and perhaps as important, an effective exit strategy. Failure to address each of these at the front end of the investment may prove very costly.
- Structure investment to secure treaty benefits: A different set of rules will apply, depending on the scope and regularity of the U.S. activities. Passive-type income will generally be subject to tax at a 30 per cent rate, which may be reduced or even eliminated by an income tax treaty.
- Avoid tax on non-U.S. income: Non-passive income attributable to a U.S. trade or business is taxed on a net basis after deductions for expenses, effectively at a federal rate of 35 percent. Generally only U.S. source income is taxed, however, in certain circumstances, non-U.S. income considered effectively connected with that business may also be taxed. For this reason, among others, U.S. entities are frequently organized to carry out U.S. business activities and ring fence the profits subject to taxation. U.S. partnerships may create a taxable presence for their foreign partners, suggesting the use of a U.S. corporation to avoid this result.
- Eliminate dividend withholding cost: Net profits distributed to shareholders are also subject to tax on a gross basis, unless reduced by income tax treaty. An offshore holding company which qualifies for treaty benefits may reduce or eliminate this dividend withholding cost, however, an analysis of specific treaty provisions must be undertaken to ensure that there are no limitations on benefits accorded the shareholder under the respective treaty.
- Beware of State Taxation: In addition to federal tax, U.S. activities may also be subject to state taxation. Each state imposes its own tax rate and rules for attributing taxable profits. States such as NY generally impose very high rates, whereas, other states may impose little or no tax. Frequently this may influence where the entity is organized and operates. In some cases, state tax incentives may exist to attract investment, which can offset initial capital requirements.
- Capitalization of the U.S. venture is critical: Loan principal repayments can be repatriated free of tax. Interest paid on such loans is generally deductible, subject to thin capitalization rules imposed on the borrower. Capitalization initially made as debt can generally be refinanced into equity should circumstances warrant, however, initial equity cannot as efficiently be refinanced into debt. Deductible nterest payments are also subject to gross basis withholding tax, however, utilizing a properly structured intercompany financing vehicle with access to treaty benefits can reduce or eliminate this cost as well.
- Exit considerations should be addressed up front: To the extent the ultimate shareholder/investor may obtain legal residency in the U.S., many of the considerations discussed above will become significantly more complex and require alternative planning structures to optimize tax results.