As a business grows and becomes increasingly involved in different markets, having ownership of a company in a different country can provide many advantages. Ownership of a foreign subsidiary can be a great way for a U.S. business to expand into overseas markets and provide additional resources to the parent company, and increased technological capabilities have made it even easier for parents and subsidiaries to work together to establish an increased global presence.
While establishing a foreign subsidiary has many economic advantages, it is important to note the increased international tax issues that this will cause for a company. Understanding the additional filing and reporting requirements for the parent company as well as navigation of international tax law is crucial. During this blog series we will discuss the tax implications of the fictional U.S. company “Parent” acquiring 100% of the fictional foreign subsidiary “Sub.”
On the U.S. side of things, it is important to be aware of filing deadlines for forms and certain elections. After Parent acquires Sub, one of the early considerations is how Parent elects to treat Sub for U.S. tax purposes. This is referred to as the “check-the-box” election, and there are two options available. One option is to treat Sub as a disregarded entity and the other is to treat it as a stand-alone foreign corporation. The foreign structure of the subsidiary could impact which option is available, as some entities are not eligible to be disregarded.
If Sub is treated as a stand-alone corporation, Sub will file tax returns under the rules of its country, and Parent will need to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, with their U.S. tax return. This form is informational to report the income and deductions of the foreign sub with no effect on the income or loss of the parent – except for possible sub-part F inclusions (which is beyond the scope of this blog). We will discuss most of the aspects of the Form 5471 in a later post in this series.
If Parent elects to treat Sub as a disregarded entity, Parent will need to include the income and deductions of Sub on its U.S. income tax return. This election, however, would most likely not be recognized in Sub’s country of formation, and Sub would still need to file a foreign income tax return. Instead of Form 5471, the Form 8858, Information Return of U.S. Persons with Respect to Foreign Disregarded Entities, will be attached to the return. This form reports information similar to that in Form 5471, but in an abbreviated manner.
Once Parent makes an election, it cannot be changed for five years, so it is important to consult a tax professional when considering the options. Once the election has been made, one of the next steps is determining how to treat the intercompany transactions. We will discuss this process in our next post.