The US International Trade Commission study looking at the key characteristics of companies that export is still a very worthwhile read. Now almost 5 years old, it compares big-company exporters with small and medium-sized exporters. One thing that jumps out from the study still rings true, in our experience: tax issues when exporting are still poorly understood by smaller companies.
The study looked at a variety of potential international expansion challenges. It surveyed what large exporters felt were the most challenging compared with smaller exporters. Interestingly, big exporters worry a lot about taxes (about 25% of them said this was a major burden when selling internationally), but smaller companies don’t think it’s a big deal. Less than 5% of smaller exporters felt that tax considerations were a concern.
On first blush, you would expect to see just the opposite. After all, bigger companies generally have experienced tax professional in house or have the resources to hire sophisticated outside tax professionals. Small companies, however, have to figure these issues out on a small budget. And as manyof you already know firsthand, good international tax advice is decidedly not cheap.
So what might this trend indicate? One possibility is that the international operations of mid-sized companies are simpler and therefore, there are fewer tax planning complexities. Smaller companies are often exporting using just distributors and agents or manufacturer’s reps.
But another possible (and troubling) explanation: smaller companies are often unaware of tax risks in international expansion. Since they don’t know about them, they don’t view it as a problem. This has generally been our experience.
Why? One of the main reasons these tax “misses” happens is because the company is very entrepreneurial, and is proud of figuring everything out for themselves. They often don’t get the tax advice they need because they may not even know the right questions to ask.
Also, there are many helpful government resources to help smaller companies export. But these agencies are not in a position to provide any guidance on tax issues. These advisors have varying degrees of skill level, but you’ll be hard-pressed to find many who have any international tax experience. This is a sought-after expertise, and experience practitioners can generally command sums far beyond modest government salaries. Also, the U.S. has never viewed providing tax advice as an appropriate government role.
Another reason is because smaller company advisors just don’t have this experience, either. Your banker, CPA, and lawyer were perfect when your company was starting out and only sold domestically. But as you expand internationally, these advisors may not be experienced enough to spot these issues, much less competently advise on them. When you start exporting with any substantial volume — or better yet, when you’re starting your international expansion plans — it’s time to re-assess all of your external advisors. 
And finally, international tax issues often lay hidden until they unfortunately come to light, often much later. And if and when they do, they can put companies in a very sticky situation indeed.
Much later may unfortunately come as part of a tax or customs audit. The most unfortunate stories are the tax issues that come to light when the company is for sale, and its owner receive a much lower offer price after the buyer discovers unresolved tax matters. And make no mistake, buyers actively look for reasons to lower their offer price.
There are some common tax issues when exporting that crop up, even when a company is only selling to foreign distributors or via sales agents. Here are 5 that crop up frequently:
1. Issues with product delivery terms. Every customer, domestic or foreign, generally prefers to have products delivered “to their doorstep.” You may be used to agreeing to this delivery term in your domestic market, but in the international arena, this is generally not an acceptable delivery term for an export sale unless you really understand what you’re signing up for.
Delivering to the foreign customer’s door means your company is responsible for clearing the items through local customs and paying any duties. You’re responsible for local customs compliance, and for any storage costs or spoilage if any problems arise during clearance. If you’re careful, you can incorporate these into the delivered cost of the product, but if you’re not experienced, these costs can really change your profitability.
Worst of all, you’re responsible for paying any local VAT or other sales taxes. While the buyer is a local company and can reclaim the VAT, you often cannot. The result is delivered product prices that are often 15-25% higher than your competitors’.
2. Creation of a “permanent establishment.” International tax professionals refer to this when you essentially are “doing business” in a foreign country. There is nothing wrong with creating a local subsidiary and tracking the income and expenses related to this company, if that’s what you planned.
But if you inadvertently do business in a way that creates a permanent establishment (“p.e.”) in a foreign country, you may find your entire company — including your U.S. operations — subject to audit by foreign tax authorities, as well as the very real possibility of being taxes twice on the same income (by the IRS and by the foreign tax agency).
Companies might create a p.e.if they locally warehouse their products. Retaining or managing local individuals who act on your behalf without carefully delineating the scope of their authority might trigger a p.e.
3. Withholding taxes. This issue generally arises when a company sends a team to install the exported product, or perhaps sends an employee to assist with after-sales repairs and troubleshooting. Companies may be aware of the 183-day annual threshold for spending time in any single country, but the threshold for withholding taxes in many countries can be very low. Canada and South Korea are two countries that have low thresholds.
In these countries, the income earned by your employees while in these countries will be viewed as if earned locally in these countries. The result? You may be required to register with tax authorities in these countries, figure out how to do foreign withholding from the employees’ paychecks, and pay these taxes locally. This may also trigger the need for the employee to prepared and file a personal income tax return in that country.
You may be able to file for an exemption, or recover some of these taxes, or be able to claim a foreign tax credit, but none of those are easy for a small exporter. And if you don’t help your employees figure out how to prepare the tax return, you may be exposing your employees to personal liability for failing to properly file and pay local taxes.
4. Taxes related to payroll & benefits. These issues can arise when you retain a sales agent (often called a manufacturer’s rep) or a local consultant. It also can crop up if you arrange with your distributor to “hire” a person that you manage and control.
All may go well, until it doesn’t. If this person is unhappy when you part ways, they may claim they were actually an employee, and were entitled to local social security contributions and other statutory contributions required by local employers. In most countries outside the U.S., employees are entitled to many statutory benefits, and individuals that we freely label as “independent contractors” in the U.S. may, in fact, qualify as employees under local law.
5. Failure to consider international tax planning.
Many small companies hear the term “international tax planning” and think of Apple’s complicated Double Dutch holding company structure. They think of entities in island tax havens used by large multinationals to shift profits and income taxes.
But even smaller companies can often benefit from having an experienced tax professional help them better structure their international sales. It can be easy to think of this as an unnecessary expense, but may save exporters a lot in taxes or significantly reduce their costs. Most international tax advisors are expensive because they are worth the money, saving companies their fees many times over.
So don’t be an exporter that just assumes tax issues are not relevant. Get educated about your risks, and take steps to address them.
What are you seeing out there?
Leave a Reply