For years, WLS Stamping & Fabricating Co. had exported its products — metal parts for the electrical, heating-and-cooling, lawn-and-garden, medical-equipment, marine and telecommunications industries — to Mexico, Ireland and England.
But it wasn’t until 2011 that the $17 million company’s foreign sales increased to a level that would allow it to set up an interest-charge domestic international sales corporation, or IC-DISC, an entity that offers significant tax savings for closely held businesses that export products.
Joan Morgan, a principal at the Cleveland accounting firm of Maloney & Novotny, explains that, at the end of the year, a parent company pays an IC-DISC a commission equal to 50 percent of export net income or 4 percent of gross foreign sales, whichever is higher.
That commission then becomes a deductible expense. The IC-DISC does not pay tax on that income as long as it distributes all profits as dividends to its shareholders — in most cases, the proprietors of the company that set it up. That dividend is then taxed at 15 percent.
“That’s huge for many exporters,” Morgan says. “A lot of small, closely held clients are not aware of this benefit.”
For WLS Stamping & Fabricating Co., an S corporation taxed at 28 percent, the difference in tax rates was big enough to merit the move. WLS chief financial officer Susan Nash says the company easily met the requirements to establish an IC-DISC: the exported products must be made in the United States and contain at least 50 percent U.S. content, and the exporter must have sufficient paperwork to prove the products were shipped overseas and sold outside the country. Because WLS didn’t set up the entity until late June, savings on its 2011 tax bill are modest.
“But next year we’re anticipating that our foreign sales will be much larger,” Nash says. “Our savings might be $20,000.”
The suggestion to establish an IC-DISC is just one of the valuable pieces of advice and information an accounting firm can provide to small- and mid-sized companies that hope to begin or expand an export business. We asked experts at local, regional and national accounting firms with offices in Cleveland for other advice they’d suggest for those looking to dip a toe or take a plunge into global markets.
Do your research.
Morgan refers all clients interested in exporting goods and services to export.gov.
The website consolidates resources from throughout the U.S. government, such as market research, trade leads, export finance information and loans and agricultural export assistance, to help American businesses plan international sales strategies.
“There are all kinds of programs available through our government,” she says. “You just need to find them and take advantage of them.”
She also recommends sba.gov, the U.S. Small Business Administration’s website, as well as international trade fairs and shows. Although a company’s first choice of foreign market ultimately will be dictated by demand for its product, she generally recommends choosing one that has a free-trade agreement with the United States, which eliminates tariffs and export duties.
“Get familiar with the exporting business before you expand into the countries where it’s very costly,” Morgan says.
Find foreign experts.
Associations with lawyers, accountants and operations experts in the country where you’re doing business are essential to navigating complex regulatory and tax landscapes.
“Every country has its own unique set of rules,” says Morgan, who includes Canada in that statement. “I have a whole network of individuals up there. I spend more time on the phone with my Canadian colleagues than I do anybody else.”
David DiCillo, a partner with the local accounting firm Zinner & Co. in Pepper Pike, singles out the importance of an export agent familiar with the policies, procedures, tariffs and duties involved in moving goods to their overseas destinations. Working with such a specialist can reduce the chances of incurring unexpected charges and delays in shipment and payment.
DiCillo tells of a client who didn’t get paid for services provided to a Chinese customer within the agreed-upon 60 days. A series of phone calls revealed that both the provider and customer had to complete paperwork in their respective countries to resolve withholding issues before payment could be made.
Pete DeMarco, vice president and partner at regional accounting firm Meaden & Moore, says a surprising number of companies are also unaware of their obligation to collect and pay the value-added tax imposed by most countries. Unlike sales tax, which is collected at the final point of sale, value-added tax is collected on an item at each point in the production chain.
He uses paper as an example: The logging company collects and pays a tax on the logs it sells to a pulp processor, which collects and pays a tax on the wood pulp it provides to the paper mill, and so forth. Companies that fail to collect and remit value-added taxes and similar charges such as the goods and services tax usually end up paying them.
“Most businesses don’t even think about going after their customers,” DeMarco says. “It’s bad business, bad PR. You eat the cost.”
To avoid such problems, most local and regional accounting firms have relationships with foreign counterparts to which they can refer clients for guidance. For example, Zinner & Co. is affiliated with the International Accounting Group, an alliance with members in more than 60 countries, while Meaden & Moore is a member of AGN International, a worldwide association of independent accounting and consulting firms in 120 nations. (Larger firms such as KPMG maintain locations around the globe.)
DiCillo recommends getting at least two referrals for each specialist you wish to consult.
“You want to work with somebody who understands how you work and wants to work with you,” he says. “The objective is to understand the way you should do business in the foreign country that you’re considering. To spend a little bit of money up front is going to save you a whole lot of headaches on the back end.”
Understand the meaning of permanent establishment.
Once a company’s presence and business activity in a foreign country rises to the level of permanent establishment, the company is subject to that nation’s tax laws. Therefore, it is important that decision-makers understand the concept.
The criteria differ from country to country. However, “most tax treaties the U.S. has with other countries provide that a company has a permanent establishment if it has a fixed place of business in a foreign country,” says Ray Polantz, a principal at Cohen & Co. But, he adds, other situations can also give rise to it.
In fact, many governments also define permanent establishment by the amount of time foreign workers spend in their jurisdictions and what they’re authorized to do there, DeMarco says.
For example, an employee who solicits sales from a home office in his foreign residence but sends the contracts to U.S. headquarters for approval may not give the company a permanent presence simply because he doesn’t have the authority to “bind the company.”
On the other hand, an executive running the company from that same home office may draw the permanent-establishment designation. DeMarco adds that employees who spend more than the number of days allowed in a country for business purposes — 183 days is a common number — may be subject to individual income taxes there.
Structure a foreign presence appropriately.
Increased exports to a country eventually prompt conversations about creating a branch or subsidiary there to better serve customers, increasing profitability by lowering production and cross-border transactional costs, and creating opportunities to exploit intellectual property outside the United States. Which option you choose “has a very significant impact on your filing, regulatory and tax issues,” according to Nick Canitano, managing director and leader of KPMG’s Northeast Ohio tax practice.
Canitano describes the foreign branch as an unincorporated arm of the parent company that is generally subject to taxes both in the United States and the country in which it is located. However, any losses incurred by the branch may be taken as a deduction in the United States under certain circumstances — a real boon for startups, DeMarco says.
“If you set it up the right way out of the gate, the U.S. company can get the losses in the foreign country to offset taxes in the United States,” he says.
The foreign subsidiary, in contrast, is a standalone tax-paying entity. One of the biggest advantages it offers is deferred U.S. tax on its earnings until they are repatriated to the parent company. (Exceptions may include passive income such as dividends, interest and royalties.)
“There are cases where that cash is destined to stay offshore forever to fund further investment and capital requirements in that country,” Canitano says.
When the earnings are finally repatriated, the parent company can claim a foreign tax credit — a dollar-for-dollar credit, subject to limitations, for certain foreign taxes already paid on that money. For that reason, it is imperative to choose a structure for the foreign subsidiary that is eligible for the foreign tax credit as stipulated by U.S. tax law.
Price it right.
Canitano warns that tax authorities look for inflated pricing on inter-company sales that minimize profits in their respective countries, in turn reducing taxes on those sales. He gives the example of a U.S. company selling parts for assembly to its Japanese subsidiary at a cost higher than normally charged. “They don’t want their country to get gypped,” he says.
To avoid inadvertent pricing irregularities that trigger scrutiny and subsequent assessments, Canitano suggests hiring an accountant to perform a transfer pricing study to determine the fair price of an inter-company sale.
“You can do it internally,” he says. “But most companies don’t have the resources.”
Know where you’re going.
Canitano points out that some countries maintain very favorable tax treaties with the United States or offer tax incentives for investing. Many others impose a hefty tax on earnings repatriated to the United States.
“There are certain countries where it is very easy to make an investment, but it is very difficult to take either the investments or the profits out,” he adds, citing China as a prime example. “So the upfront planning of where to invest is very important.”