Moving the Management and Control of a Foreign Corporation to Achieve Favorable U.S. Tax Results, Part II

If a foreign company is owned by a company in a country with a good tax treaty with the US, the dividends paid by the foreign company to the US may be taxed at a lower rate. Another option is to have the foreign company owned by another company in the same country to avoid certain taxes. It’s better to use the same-country exception because tax rules are expiring soon. It’s important for U.S. citizens to set up their business structures carefully to avoid certain taxes. To do this, they need to make sure that their contracts with foreign companies are worded in a specific way. The contract should give the foreign company the right to choose who provides the services, even if they already know who it will be. This helps the U.S. citizen avoid extra taxes. Before §7874, U.S. companies would do “inversion” transactions to become foreign-based and avoid paying U.S. taxes. They would transfer their foreign subsidiaries to the new foreign parent to keep their earnings from being taxed in the U.S. They would also make deductible payments to the new foreign parent in a low-tax country to reduce their U.S. tax. This allowed them to defer paying taxes on their foreign earnings. Section 7874 is a law that aims to prevent companies from avoiding U.S. taxes by moving their headquarters to a foreign country with minimal business activity. It applies to two types of transactions: if the former shareholders of a U.S. company own 60-80% of the new foreign parent company, certain tax benefits are limited for 10 years; and if the former shareholders own 80% or more, the new foreign parent company is treated as a U.S. company for tax purposes. For the law to apply, three conditions must be met: the U.S. company becomes a subsidiary of a foreign company, the former shareholders own a certain percentage of the new foreign parent company, and the new foreign parent company does not have substantial business activities in its home country compared to its total activities. The IRS recently made rules to determine if a group of companies has enough business activity in a new foreign country. They used a “facts and circumstances” test and a safe harbor test. Under the “facts and circumstances” test, they look at things like how long the companies have been in the foreign country, what kind of business they do there, and if they have a lot of employees and investors there. The safe harbor test says the group has enough business activity if at least 10% of their employees, assets, and sales are in the foreign country after they buy a company there. If a big American company wants to merge with a foreign company to avoid paying high taxes, it won’t work if the foreign company doesn’t have much business going on in its country. But there are still ways for the American company to plan around these rules and find ways to avoid paying high taxes. A U.S. company wants to avoid paying a lot of taxes, so they create a new company in the U.K., and then move its management to Hungary. This allows them to take advantage of Hungary’s lower taxes. They also make certain payments to the new parent company in Hungary to reduce the taxes they pay in the U.S. This is all legal because of certain tax treaties between the countries. If a company moves its management and control to a country with lower taxes, it can save a lot of money. This means following the laws in the new country, and if done right, the company can avoid some U.S. taxes. It’s surprising that the U.S. tax rules still focus on where a company is formed, rather than where it is actually managed. There was a proposal to change this in 2005, but it didn’t go through. This means that companies can still choose where they want to be based for tax reasons. Qualified foreign corporations can pay dividends at a lower tax rate in the US. To be considered a qualified foreign corporation, the company must meet certain criteria such as being incorporated in a US possession, having a comprehensive tax treaty with the US, or having stock that is readily tradable on a US securities market. There are also bills that may affect the tax treatment of certain foreign dividends. It’s important to understand these rules when doing business internationally to minimize tax obligations.

 

Source: https://www.floridabar.org/the-florida-bar-journal/moving-the-management-and-control-of-a-foreign-corporation-to-achieve-favorable-u-s-tax-results-part-ii/


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