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Tuesday's Tax Tip: When In Rome...

Posted by Gayle Kesten Tuesday, Mar 18, 2008, 08:15 AM ET

As if staying on top of your taxes isn't hard enough here on American soil, the landscape becomes all the more complicated the minute you conduct business overseas.

To learn about what you need to take into account, I spoke to Larry Harding, president and founder of Annapolis, Md.-based High Street Partners, which provides such business services as cross-border accounting, payroll, finance and HR to companies taking their offerings abroad. Our discussion hit on three major points:

1. Permanent Establishment (PE): Trigger one of these and prepare to pay taxes, and potentially very steep ones. In a nutshell, if a person representing your business outside of the United States is engaged in what's deemed to be a profit-making activity, then you're responsible for paying corporate income tax at that country's rate. In the United Kingdom, for example, it's more than 30 percent. "If you also realize sales to customers in-country, it can be an enormous tax liability," Harding warns. (Click here to get a better idea of tax rates around the world.)

Ouch. One way to minimize the taxes you'd owe would be to formally set up a foreign subsidiary whereby you pay that country's tax rate on only the portion of business conducted there. "You want to make sure, to the degree that you can, that another corporate entity besides the one selling in-country can take the PE," Harding told me.

2. Contractor vs. De Facto Employee: Just like here at home, be careful when you bring someone aboard as a contractor overseas; the relationship can still be construed as employer-employee. For example, if that person provides services for only your company or carries a business card bearing his name and your company's, that contractor may be deemed an employee in the eyes of local authorities. That leaves your business open to be sued by that person for not fulfilling employer obligations (think: benefits, pension, etc), plus you'll likely be fined for not paying that country's social taxes, which are significantly higher than our 7 percent or so FICA rate -- as much as 40 percent or more, Harding says.

3. Value Added Tax (VAT): In the 27 countries within the European Union, the end consumer winds up being the only one who pays what in the United States is analogous to a state or local sales tax. Businesses are meant to be VAT tax collectors, not payers; their role is to pay over VAT collected from customers and get a refund of any VAT paid to vendors or on imports. When a business pays a VAT, it should usually be recoverable, if the rules are followed. The rules, however, stipulate that any business making “VAT-able” sales in the EU, even if the business itself is based outside the EU, must be VAT registered, must keep VAT records and must file regular VAT returns. These VAT requirements throw many businesses for a loop, according to Harding, and the penalties for noncompliance are high.

Perhaps Harding's best advice of all? Take your time, do your due diligence and seek out the proper advice, lest you find yourself headed down a one-way road filled with fines.

Previous Tuesday's Tax Tips:

Overlooked Deductions

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