United States corporations can be taxed twice—once when they make money and once when that money is distributed to the company’s shareholders. As the owner of a foreign company, you may also be subject to this double taxation if you do business in the United States. First, you may have to pay tax on the income you earn in the United States. Second, you may also be required to pay the branch profits tax if earnings in the United States are sent back—or deemed sent back—to the business or business owners in your home country.
Not every business is subject to the branch profits tax. It all depends on how your company does business in the United States, whether you meet certain limited exceptions to branch profits tax liability, and the legal advice you get before you start doing business or investing in the United States.
What Is the Branch Profits Tax?
The branch profits tax is the Internal Revenue Service’s (IRS) attempt to treat United States corporations and foreign-owned corporations the same. From the IRS’s point of view, a non-resident of the United States should pay the same taxes whether that non-resident does business in the United States through a foreign-owned corporation or a United States corporation. Following is a basic overview:
- When a foreign investor owns a U.S. corporation, the net profit is taxed. Then, when the corporation pays a dividend to that foreign shareholder, a withholding tax is imposed. Because the U.S. has the authority to tax a U.S. corporation, there is no need to impose the branch profits tax.
- When a foreign investor owns a non-U.S. corporation, the net profit is taxed. Because the U.S. does not have the legal authority to tax a dividend that is paid from a foreign corporation to a foreign shareholder, the United States imposes the branch profits tax.
Who Pays a Branch Profits Tax?
Individuals, U.S partnerships, and U.S. trusts do not pay branch profits taxes because they are taxed in other ways. Foreign corporations pay the branch profits tax if the following conditions are met:
- The foreign entity is formed pursuant to the laws of a country other than the United States
- The IRS views the foreign entity as a foreign corporation
- The foreign corporation is engaged in a trade or business in the United States. This includes owning real estate.
- The foreign corporation has income from business activities or holdings in the United States. This is known as effectively connected income. For example, making money on the sale of U.S. real estate results in effectively connected income.
How the Branch Profits Tax Works
A branch profits tax must be paid on after-tax net profit that is earned in the United States and is sent back—or deemed sent back—to the owners in a country other than the United States. If profit that’s earned in the United States is reinvested in the U.S. business interest, no branch profits tax will be imposed.
First, the foreign company calculates its profits from U.S. investments and business activities. The foreign company then pays regular corporate income tax on that profit. After the income tax is calculated, the remaining profit that is provided to the foreign business owners is subject to the branch profits tax. The branch profits tax rate is typically 30% unless an exception, such as a treaty, lowers that rate.
Branch Profits Tax Exceptions
As with many United States tax laws, there are exceptions to the branch profits tax. Even if your business would typically be subject to a branch profits tax, you may not be required to pay a branch profits tax—or your tax burden may be reduced—if:
- There is a treaty between the business’s home country and the United States that reduces your branch profit tax liability.
- You end your business interest in the United States, all of the assets are liquidated, and all of the money goes back to your home country.
- Your foreign corporation profited from the sale of stock in a United States corporation. This exception applies to stock interests only and not to real estate property.
Get Legal Help Before Doing Business in the U.S.
As the owner of a foreign corporation, it is essential to seek legal help before you establish a company, purchase property, or become involved in other U.S. business dealings. There are a variety of choices when it comes to creating a business entity, and talking to experienced lawyers before you get started can save you time and money. We can help you establish a business structure that meets your unique needs and minimizes your tax burden.
And while it’s best to call us before you start to do business, it may not be too late for us to help you if your entity already owns property or does business in the United States.
There is not one tax option or business structure that works for all foreign entities. Do not trust this important decision to a broker or a friend. Instead, please call Antonio Gastélum and María Elia Gastélum today. Our firm will provide you with trustworthy and reliable representation so you can make the right decisions.