There are multiple routes that a foreign company can take to establish its presence in the U.S. market. Two common forms of such business growth are creating a U.S. subsidiary and establishing a U.S. branch. A branch is simply an extension of the parent company; a way for it to enter the U.S. market without incorporating in the U.S. A foreign company can use a branch to quickly enter the market, avoid formally creating a subsidiary, and retain control over branch operations without creating a new corporate structure. Because a branch is not a separate legal entity, increasing the parent company’s exposure to liability is a primary disadvantage. Other disadvantages include establishing credibility with investors and customers and obtaining financing.
What are the Tax Filing Requirements of a U.S. Branch?
Foreign corporations are required to report their U.S. activity to the IRS annually by filing Form 1120-F. If the corporation maintains an office or place of business in the U.S., it must file the form by the 15th day of the 4th month after the end of its tax year. If the corporation does not maintain an office or place of business in the U.S., it must file the form by the 15th day of the 6th month after the end of its tax year. So, a calendar year-end foreign corporation with an office in the U.S. must file its 2021 Form 1120-F by April 15th, 2022. Filing extensions are available. Being engaged in a trade or business is enough to trigger a foreign corporation’s filing requirement even if no U.S. source income is generated. A separate balance sheet must be prepared for all the domestic assets and liabilities in the U.S. for the foreign corporation.
Branch Profits Tax
U.S. tax law imposes a 30% branch profits tax on a foreign corporation’s U.S. branch dividend equivalent amount. The term dividend equivalent amount means a foreign corporation’s earnings and profits (ECEP) for the year that are effectively connected with a U.S. business, to the extent that they are not reinvested in branch assets. The tax is in addition to U.S. corporate level income taxes, though it may be reduced under a tax treaty.
The purpose of the branch profits tax is to treat U.S. operations of foreign corporations in a similar manner as U.S. corporations owned by foreign persons. The tax will apply if the amount of interest deducted by the branch on its U.S. tax return exceeds the amount of interest it actually paid during the year. The foreign company is not required to make estimated tax payments for the branch profits tax.
Calculating the Branch Profits Tax
The branch profits tax is calculated by first determining the dividend equivalent amount for the taxable year. Once again, this is the corporation’s after-tax net effectively connected income (ECI) that is not reinvested in a U.S. business (and thus treated as though the funds were repatriated). The taxable base for the branch profits tax increases or decreases in direct relation to the US net equity of the branch. The dividend equivalent amount can never be less than zero and there are limitations based on accumulated ECEP.
For example, foreign corporation “Miami Machinery,” has $1,000 U.S. net equity at the close of 2020 and $100 of ECEP for 2021. Miami Machinery acquires $100 of additional U.S. assets during 2021 and its U.S. net equity as of the close of 2021 is $1,100. In computing Miami Machinery’s dividend equivalent amount for 2021, its ECEP of $100 is fully counterbalanced by the $100 increase in U.S. net equity during 2021. Miami Machinery has no dividend equivalent amount for 2021.
In contrast, if Miami Machinery acquired only $40 of additional U.S. assets during 2021, its U.S. net equity as of the close of 2021 is $1,040. In computing Miami Machinery’s dividend equivalent amount for 2021, its ECEP of $100 is partially counterbalanced by the $40 increase in U.S. net equity during 2021. Miami Machinery has a dividend equivalent amount of $60 for 2021.
Being engaged in a trade or business is enough to trigger a foreign corporation’s U.S. tax filing requirement, even if the corporation hasn’t incorporated domestically. If you own a foreign corporation and plan to do business in the U.S. through a branch, you face increased exposure to liability that may not outweigh the administrative benefits. Our experienced business law attorneys can help you figure out the best option for you if you wish to do business in the U.S.