One of the less-glamorous, but most important, aspects of doing business internationally is planning for the tax implications of overseas business operations. For example, many U.S. companies aren’t aware of the concept of “permanent establishment” as it relates to business activities performed in a foreign country.
There are many different ways to “do business” overseas, and not all of them involve setting up an actual office or plant in a foreign country. If your foreign activities are defined as creating a permanent establishment, your company and employees may be obligated to pay taxes in the foreign country on profits derived from products sold and services provided there.
Beware Permanent Establishment
Most countries recognize the concept of permanent establishment, which can be satisfied when a company merely has one or more employees located in a foreign country for a period of time. It is not necessary to have a physical location (e.g., office or manufacturing plant) in the country in order to be considered a permanent establishment.
Fortunately, the U.S. has income tax treaties with many countries that define the conditions that can create a permanent establishment. These treaties allow companies to operate in a foreign country without creating a permanent establishment, thus avoiding taxation. Your tax advisor can review with you the rules for specific countries.
Being considered a permanent establishment can affect not only the payment of taxes by your business, but also by your employees, who may be required to pay personal income taxes to the foreign country where they performed services. This may be the case even if the employee was paid, and taxes were withheld, in the U.S. While the employee may be eligible for a refund from Uncle Sam of foreign taxes paid, he or she still must pay the tax upfront.
What About Value Added Taxes?
In addition, companies with permanent residence in a foreign country may be responsible for collecting and remitting Value Added Taxes (VATs). In Canada, for example, there are some very specific rules dictating when foreign companies must collect the Goods and Services Tax (or GST, Canada’s VAT). A surprising number of companies doing business in Canada are unaware of their obligation to collect and remit the GST.
The tax implications of doing business overseas can be extremely complex, and vary widely from one country to another. Before embarking on international business expansion, you should discuss your plans in detail with your accountant or a tax professional to avoid unpleasant surprises later.
How to Handle Social Security Taxes
The issue of paying Social Security and Medicare taxes on wages earned outside the U.S. is a little bit murky. Where these taxes should be paid depends on a number of factors, such as which country you and/or your employees will be working in and how long you’ll be in the country.
In general, U.S. Social Security and Medicare taxes do not apply to wages for services performed as an employee outside the U.S. However, self-employed U.S. citizens or residents are generally subject to U.S. Social Security and Medicare taxes regardless of where the self-employment income is earned.
The good news is that the U.S. has entered into “totalization agreements” with 21 other countries to try to eliminate double social security taxation and combine social securities from two or more countries. These agreements allow employers who are transferring employees to work at a related company (like a subsidiary) overseas to continue covering the employees in their current social security system and opt out of the other country’s system.
To qualify, the overseas subsidiary must obtain a certificate of coverage from the U.S.- based company verifying that its employees are covered in the U.S. system. Then the subsidiary won’t be required to pay taxes into the foreign company’s social security system on behalf of U.S.-citizen employees, nor will the employees be required to pay any employee share of these taxes to the foreign government.
For a complete list of countries with which the U.S. has totalization agreements, visit www.ssa.gov/international/agreements_overview.html.