Business Tips

Foreign companies wishing to do business with customers inside the United States face a daunting task when trying to ensure they do create a requirement to comply with federal tax code or legal requirements. The regulatory landscape is an ever-changing minefield that even taxation experts often only guess at. Legal opinions change with every court case, and in the case of digital media the rules are almost always lagging behind the latest technological innovations.

The Internal Revenue Service and U.S. Federal courts mainly attempt to apply existing regulations to the latest technological innovations. This works as an ad hoc measure in some cases, and in others it only confuses and complicates matters. When seeking to do business within the United States a company will put itself in the best position by seeking out expert opinions rather than relying on “what everyone knows” or even what works for a similar company.

The rules for physical products are much more firmly established in both federal code, and state laws. These codes and laws are often of some help in determining what a company is required to do in order to be compliant with digital media, but not all the time. Digital media is a unique product that can not be easily fit within the existing framework. An examination of what laws and code might be applied to a foreign company selling within the United States is at least somewhat helpful though.

A very generalized statement is that a foreign company, not incorporated within the Unites States and without a nexus in the Unites States is normally only subject to taxes on the income it derives from sales within the United States. This is different for corporations that are classified as domestic corporations. For these corporations all income is subject to taxation regardless of source.

Often foreign companies want to employ United States citizens directly. For internet based companies this can lead to a complex situation. When it comes to foreign corporations employing United States citizens, the situation is largely dependent on the taxation treaty between the foreign corporation’s nation and the Unites States. Normally all wage payments over approximately 3000 per year must comply with the normal withholding rules for income tax, FICA, and social security/Medicare unless exceptions apply or treaty relief is available.

These withholdings apply to workers that are directly employed by the company, and the company must submit the appropriate paperwork to support the employees withholding of taxes. When a company employs an independent contractor, a worker who is not legally a part of the company, then the independent contractor withholds these taxes on their own.

An additional consideration is that direct employment can result in a worker being seen as an “Agent” of the company. If this is deemed the case, a company can inadvertently create a nexus for taxation where they did not intend to do so. Before hiring a United States citizen, a company should consult with a tax specialist within the state the intended employee lives. This will ensure both federal and local taxation rules are complied with.

Taxation is often the result of the company having a “Permanent Establishment” in the United States. Income tax treaties normally contain a clause regarding what constitutes a Permanent Establishment in the United States. The general rule is that there is a Permanent Establishment if there is a fixed place of business where activities are conducted, or there is an agent acting on behalf of the enterprise that has the authority to conclude contracts binding on the enterprise. If neither of these exist, the business is often not seen as having a permanent establishment.

In regards to what constitutes a US Trade provides the following considerations to be evaluated. There are no actual IRS definitions and the below is a guide based on court decisions and a circumstantial analysis. These considerations are
The business must have a profit motive.
Activities must be “considerable, continuous, and regular”.
An Agents actions in the United States may result in a US Trade or Business.

The subject of state taxation gets even more complicated. Treatise do not generally apply to state taxation and businesses must be even more careful in how they operate to avoid creating a taxable situation. The bar for what constitutes a nexus is much lower for states, and merely having an employee in a state may be sufficient to establish a taxable presence.

Foreign corporations should carefully review all bilateral tax treatise to ensure they comply with the requirements to obtain the relief the treaty provides. Tax treatise can reduce the taxes imposed on a corporation by a considerable amount. Again there is no hard and fast rules in regards to tax treaty’s and they must be continuously monitored for any changes that may result in a change to the business operations of a foreign company.

Further complicating the taxation scheme is the issue of cloud computing. The draft definition of cloud computing is provided by the National Institute of Standards and Technology (NIST). This definition is a system “in which cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction. This cloud model promotes availability and is composed of five essential characterstics, three service models, and four deployment models”.

There are four “types” of cloud infrastructures, each which impacts taxation in a different way. These are a private cloud, a public cloud, a community cloud, and a hybrid cloud. The determination of which cloud to make depends largely on security and privacy concerns. Each type of cloud can affect the tax circumstances for a foreign corporation.

The issue is mostly the physical location of the cloud servers. If the state taxes at point of use, is that where the user resides, or where the program resides? Can you have taxes applied separately by two different states who regard these issues differently? These questions are not fully answered by statues in most states, although regulations are still being drafted to do so. This once again is a state by state problem that requires thorough research before selecting a service provider.

Cloud computing is often seen as the great future, and it does provide some of the best ways forward for many companies. The ambiguity of the impact this has on taxation is something that requires great deliberation before any cloud strategy. There are few answers that apply across the board, and it would be easy for a company to implement a cloud strategy only to run into serious tax concerns that it did not anticipate.

The main thing to take away from cloud computing is that while the concept is one that affords a company with greater flexibility and scalability in its operations, it requires a professional in United States Internal Revenue Code to successfully implement within the United States. The layperson should avoid making any decisions without consultation, as regulations change frequently.

Internet based businesses located outside the United States have few clear and definitive guides to follow. This is not due to lack of effort from lawyers and legislators, and many articles and blogs have been written about different aspects. Unfortunately the hard truth is that the subject is not one that is able to be boiled down to a manageable list of activities.

Conducting business within the United States is a complex, confusing, and complicated endeavor. To fully comply with codes, laws, and regulations is something that requires specialized knowledge and skills. To ensure that there are no hidden penalties or broken regulations a company is almost required to hire a tax professional to advise them before they attempt to break into the United States market.