From Outbound to Inbound: A Tech Company’s Guide to Expanding Globally (Part Two - Inbound Transactions)

HOST: Welcome, everybody, to another episode of the Cherry Bekaert Technology Industry podcast. My name is CHRIS DELCAMBRE, a tax partner here in the Cherry Bekaert office based in D.C. I am a C Corp specialist and today I am joined by Raj Tripathy, a Managing Director in our International Tax practice.

CHRIS DELCAMBRE: Thanks for joining me today, Raj.

RAJ TRIPATHY: Thank you, Chris. I am glad to be here.

CHRIS DELCAMBRE: Raj, for the listeners, why don't you give a little bit of a background? Your background is extensive, especially with international tax, so it would be good to hear your qualifications and expertise.

RAJ TRIPATHY: Absolutely. Thank you, Chris. I have been doing U.S. international tax, both outbound and inbound, for the last 25-plus years.

I help U.S. global clients with global expansion, tax due diligence, structuring, and U.S. international tax compliance. I also assist foreign companies coming into the U.S. with their international tax issues.

Since 2008, I have also been leading the U.S.-India corridor for my prior firms, coming from the Big Four, and now with Cherry Bekaert. We help U.S. clients who are trying to expand, set up back offices, or establish R&D centers in India.

We also support Indian companies that are expanding or looking at supporting the U.S. from an inbound perspective.

CHRIS DELCAMBRE: I have worked with you personally, Raj; you definitely know your stuff. I want to discuss what those terms mean.

I can’t think of anybody better to provide the definitions for those or go over them briefly. Can you break down "inbound" versus "outbound" for the listener, and then roll into "permanent establishment" for both as well?

RAJ TRIPATHY: Absolutely, Chris. The three terms you mentioned—outbound, inbound, and permanent establishment (which I will acronym as PE)—are three terms always used in U.S. international tax.

U.S. international tax rules state that any U.S. company, corporation, partnership, individual, or trust must report their worldwide income in the U.S. This triggers a filing requirement.

When we talk about outbound, it means a U.S. company looking at setting up a foreign subsidiary, a foreign branch, or investing in a foreign company. You have to consider the U.S. international tax filing requirements and rules, plus the tax treaties the U.S. has signed with most countries across the globe.

That is more of an outbound perspective: a U.S. company going outside the U.S. to do business, set up operations, and hire employees or consultants.

If you have a subsidiary, you may have to file Form 5471. If you have a partnership, you have to file Form 8865.

You also have to consider the "check-the-box" concept. This is a U.S. concept where a U.S. company can set up a foreign subsidiary and elect to make that entity a flow-through, a partnership, or a disregarded entity for tax purposes.

Regarding the permanent establishment (PE) concept, Article 5 of standard OECD tax treaties states that establishing a presence in a foreign country without a legal entity could trigger a PE.

This also triggers withholding taxes and foreign tax credits. To avoid double taxation, treaties help analyze what kind of credit you can claim in the U.S. on taxes paid in a foreign country.

Treaties also help manage withholding taxes when bringing back profits like dividends, rents, royalties, or capital gains. That is the outbound perspective.

Let's switch gears to inbound. This is a similar concept but involves a foreign company looking to do business or set up operations in the U.S.

They must consider how to do business in the U.S. and whether they should set up a corporation, an LLC, a branch, or a partnership. There are 50 states in the U.S., so a foreign company must analyze which state is most beneficial for credits, incentives, and exit plans.

In addition to federal and state income tax, they must consider sales and use tax, international tax, and proper transfer pricing. Some states also levy franchise taxes or city taxes.

The last thing any company going outbound or inbound needs to keep in mind is the PE, or permanent establishment. This is an international tax concept meaning a business could be subject to tax in a foreign country where they conduct business without having a legal presence.

Common types of PE exposure under Article 5 include fixed-place PE exposure and dependent agent exposure. These concepts must be analyzed properly to manage risk.

In short, PE is the creation of a taxable presence by a corporation outside its territory. This is often overlooked when companies hire consultants in a foreign country to export goods or provide services without a legal entity.

If a company does not understand the PE concept, there could be legal issues in addition to tax issues.

CHRIS DELCAMBRE: Thank you for that, Raj. These terms are a bit more complex than we might think.

Let's start with outbound, as it is a common topic in the D.C. market. Can we use an example, Raj?

You and I are working with a U.S.-based company that recently took on direct-hire employees in a foreign country—what some might call "W-2 employees." Unfortunately, we weren't part of the early planning, but luckily we were brought in before it went too far.

Can you explain the problems encountered there and what direct hiring in another country means from a U.S. and foreign tax perspective?

RAJ TRIPATHY: Absolutely. When you hire an employee in a foreign country, you must perform proper due diligence regarding their roles and responsibilities.

What service is that person rendering? Is it sales and marketing or software development? We must determine if those services fall under ancillary and auxiliary definitions to mitigate PE risk.

We also need to know if the individual is full-time or part-time. Hiring a consultant for 20 or 40 hours could construe a dependent or independent agent relationship.

You also have to consider the local country's domestic law, which sometimes overrides the treaty. Hiring an employee might be construed as creating a Qualified Business Unit (QBU), which triggers additional filing requirements in both the U.S. and the foreign country.

Many IT companies hire consultants or employees for software development and do not realize the risk to their Intellectual Property (IP) parked in the U.S. You must ensure proper ring-fencing is done through transfer pricing.

You do not want a foreign country claiming that because an employee was accessing your network and doing development there, the IP rights belong to that local country rather than the U.S.

CHRIS DELCAMBRE: The IP issue is so important and often a terrible misstep. Many companies say they don't have a permanent establishment because they only use "contract labor" or 1099-style workers.

Can you speak to the difference between a direct employee and direct contracting in a foreign country?

RAJ TRIPATHY: When you hire a consultant or employee directly from the U.S. and pay their salary, they are a direct employee. Many companies use a third-party firm, such as a PEO (Professional Employer Organization), to hire on their behalf.

While the worker is considered a contractor for the U.S. company, the same PE and IP analysis must be performed. The PEO contract will usually state they handle withholding and employment relationship filings, but the PE risk remains the company's responsibility.

A PEO is a tool for the short term—perhaps six months to a year. Once you decide to be there long-term or hire more employees, you should establish a legal entity to mitigate IP and PE risks.

CHRIS DELCAMBRE: That is super important. The rules abroad are not the same as the U.S. rules for contractors versus W-2 employees.

In the D.C. market, we see government contracts where work must be performed abroad. In these situations, a PEO might not be the best tool.

Raj, can you touch on when we might create a foreign entity rather than just using a PEO?

RAJ TRIPATHY: If you are going to a country on a short-term basis with one or two employees, a PEO can work. However, if you need multiple resources, the advice is to have your own presence.

Before setting up a legal entity, reach out to international tax advisors like Cherry Bekaert. We perform feasibility studies covering local laws, treaty networks, and exit strategies.

For example, we are helping a client set up operations in the Middle East and a back office in an Asian market. We analyze which countries have the best treaties to ensure a good repatriation strategy for profits or dividends.

A strong treaty network can lead to lower or zero withholding taxes on dividends or royalties. This allows for a tax-efficient structure that minimizes the overall global effective tax rate.

CHRIS DELCAMBRE: Those are key terms: exit plan, dividend repatriation, and treaties. Those keep popping up.

To our listeners, we have a lot to cover, so we are going to end this episode and pick up with a second episode covering the inbound piece of these transactions.

If you have questions about international tax planning, feel free to reach out to Raj Tripathy, myself, or the Cherry Bekaert team. You can visit cbh.com/itx to learn more.