International Business Strategies
July 7, 2017
When thinking about growth opportunities, many businesses today come to a standoff between expanding domestically and expanding abroad. While many companies want to consider domestic growth, they often come to a realization that there are international consumer markets that can benefit from their products and/or services just as much. Therefore, many companies decide to go the international route.
More and more companies are planning their international business strategies with specific results in mind: increase profits by a combination of increasing sales and decreasing expenses, including tax expenses. Some of the international strategies that large businesses are using include repatriation of funds and corporate inversion.
Repatriation Versus Corporate Inversions
Through the practice of repatriation, businesses with operations in foreign countries will send profits back to the country in which its international headquarters is located. The concept of double taxation has to be considered when using repatriation, since the United States will also tax the profits received from foreign operations.
Through the practice of corporate inversion, corporations with significant operations in foreign countries will decide to move their headquarters to a different country where tax laws are more advantageous to their operations and to hopefully avoid double taxation, where businesses are taxed on foreign income abroad as well as when the income is repatriated to the country in which the company’s global headquarters is located.
Other businesses, both large and small, are using a more basic format of conducting international business, such as exporting or selling through the use of a foreign agent abroad. Some businesses will also merge with or acquire a foreign-based corporation in order to accomplish this more effectively and more quickly. In other instances, two U.S.-based companies may agree to merge and then jointly decide to relocate their headquarters to a foreign country. Some businesses will try to justify this relocation by believing that corporate inversion is the best approach in order to remain competitive against foreign-based competitors that are located in countries with lower corporate income tax rates.
Corporations have been increasing their customer bases and market shares by expanding into international markets ever since the start of globalization. Not every company, though, will decide to have operations in each region where its target customers are located. This is because of the costs associated with having operations abroad, which include operational costs, corporate governance costs, regulatory costs and tax costs.
Some businesses will declare that foreign profits are permanently reinvested in overseas operations in order to avoid double taxation and keep their profits abroad. This will also allow the business to further expand their foreign operations. Additionally, the company would use its U.S.-earned profits to expand their domestic operations. Unfortunately, by not repatriating the foreign earned income, the business may not be able to repurchase common stock or issue, declare and pay as much of a dividend than if it had decided to repatriate the foreign-earned income. By repatriating foreign-earned income, the cash reserves in its U.S. bank account could increase significantly.
Making Use of Tax Holidays
There are certain times, though, when it becomes more advantageous for businesses to repatriate their foreign profits rather than keep the profits permanently reinvested in their foreign operations. These times are referred to as “tax holidays.” When tax holidays are granted, businesses are able to temporarily repatriate profits from foreign operations at a significantly lower corporate tax rate than the normal corporate income tax rate. During these holidays, more and more businesses decide to repatriate their foreign profits and either expand their operations in their home country, purchase stock, pay dividends or keep the cash deposited in the businesses’ U.S. bank accounts. It is important to note, though, that these tax holidays do not exempt the foreign-earned income from being taxed in the United States; it only reduces the statutory tax rate that would be applied to the foreign-earned income.
These tax holidays also encourage businesses to wait until they repatriate rather than repatriate each month, quarter or year. Many businesses will decide to wait to repatriate when the tax laws favor it and to pay a lower tax expense. If the international tax law ever makes it more advantageous for businesses to repatriate profits from foreign operations by lowering the repatriation tax rate on a more permanent basis, more and more businesses may decide to repatriate more quickly and reinvest the funds in expanding operations in their home country.
Under the current international tax law, it is estimated that approximately $2.6 trillion is kept abroad rather than being repatriated back into the United States. This means that the U.S. government is not receiving the tax income that it would receive if the businesses decided to repatriate their foreign earnings. This tax income could result in hundreds of billions of dollars in tax revenue for the United States, depending on the business’ tax rate and any foreign tax credits that may apply. When a tax holiday is granted, the amount of funds kept abroad is significantly reduced, but when the tax holiday ends, the amount of funds kept abroad quickly and significantly increases again.
When considering repatriation rather than inversion, businesses need to keep in mind that for many their effective tax rate is considerably lower than their home country’s statutory tax rate, which may reduce the benefit of the tax holiday. It is also possible that future international tax laws may include a tax rate for foreign income that is kept abroad even if it is not repatriated. That tax rate may be lower than the tax rate if the funds were repatriated, but it is important for each business with foreign income to study the advantages and disadvantages of each strategy and make the best decisions that fit their strategy. If there is such a tax rate in the future that would tax income kept abroad and not repatriated, it may even be cheaper during future tax holidays to repatriate rather than keep the foreign-earned income invested abroad.
This article appeared in the July/August 2017 issue of New Jersey CPA magazine. Read the full issue.