Expanding into the US
Expanding into the US
The US represents a huge untapped market for UK businesses. However, any business considering expanding into the US need to be aware of the complexities of the US tax system.
In fact, many UK businesses which provide services digitally may have already engaged a customer in the US and begun their expansion without realising.
In our experience, UK businesses evolve through three stages of expansion into the US market:
1) Toe in the water
A UK business may engage an initial US-based customer which helps them realise the US could represent a potential new market for them. In this stage the business has no presence in the US, engaging customers through the UK business and providing services from UK-based employees.
2) Charting a course
The business may begin sending individuals to the US on business trips, or even engaging a US- based contractor to help service its US customer base. At this stage US customers are still engaged through the UK business, however the services may be provided by UK employees and facilitated by US contractors. During this stage the business may consider more formal US expansion plans.
3) Setting sail
After a successful testing of the waters and the growth of the US client base, the UK business may incorporate a US subsidiary which can engage US customers, employee US employees and ringfence the US federal and state tax liabilities to the operations of the US subsidiary, providing protection for the UK parent.
US expansion – key tax concepts
Are you conducting a US Trade or Business?
The US imposes US tax on the worldwide income of US resident individuals and corporations, and on the US income of non-US individuals and businesses. A US resident corporation is one which is incorporated under the laws of a State of the US, with all other corporations deemed foreign corporations. Under these rules, a UK limited company is deemed a foreign corporation for US tax purposes, and its exposure to US tax is therefore limited to its US income only.
Under US law any income earned from a US trade or business is deemed Effectively Connected Income (ECI). Effectively connected income is subject to US Corporation Tax at a rate of 21% on the net taxable profits and is reported on a tax return filed by the foreign corporation. Any income earned which is not connected with the operation of a US trade or business is likely defined as Fixed Determinable Annual or Periodic (FDAP) income, which is subject to a 30% gross withholding tax, which is reported on a tax filing submitted by the US payor.
Unfortunately, the US tax code does not include a comprehensive definition of what constitutes a US trade or business, and instead the facts and circumstances of each case must be considered. However, it is generally accepted that a US trade or business exists if a foreign corporation is conducting considerable, continuous and regular economic activity within the US.
In essence this means the foreign corporation is taking active steps to generate a profit from US based customers.
Have you created a Permanent Establishment?
While under US law any income earned in connection with a US trade or business is subject to US Corporation Tax rules, the US/UK tax treaty offers UK limited companies some additional protection from paying US Corporation Tax.
Under article 7 of the US/UK tax treaty, business profits of a UK limited company are only subject to US Corporation Tax if they are earned in connection with a US trade or business which it operates through a permanent establishment in the US. If no permanent establishment exists in the US, the UK limited company is afforded ‘treaty protection’ from paying US Corporation Tax in relation to its US effectively connected income.
A permanent establishment is clearly defined in article 5 of the US/UK tax treaty as including a place of management, a branch, an office, a factory or workshop. However, some exceptions exist for storage of goods in the US. A permanent establishment can also be created by an individual physically present in the US who has the authority to conclude contracts on behalf of the UK limited company, and habitually does so – unless they are an independent agent who regularly acts on behalf of multiple businesses.
Any extended physical presence of an employee or director in the US runs the risk of creating a permanent establishment of the UK limited company, and it is at this stage of the expansion that many businesses consider creating a US subsidiary.
What about state tax?
The US/UK tax treaty is an agreement between the UK Government and the US Federal Government, and therefore has limited direct application when it comes to state Corporation Tax rules.
In general, a business will be subject to a state’s tax rules if the business has ’nexus’ within the state. Nexus can be determined differently by each state; however, it is generally considered a connection between the business and the state. Nexus can be created through the presence of an office, employees, or customers of the business within the state, but a thorough state nexus review will consider all relevant facts and circumstances and should be considered on an on-going basis. Once a business creates nexus in a state it will be required to file a state Corporation Tax return and pay state tax on the portion of its profits which are attributable to the state.
A UK limited company that conducts a US trade or business but does not create a permanent establishment in the US may be protected from paying federal Corporation Tax but may still create nexus in a state and be liable for state Corporation Tax on a portion of its profits.
US tax system overview
When it comes to US tax, there are three distinct systems which are relevant to any business expanding into the US market.
1. Federal Corporation Tax
A federal corporate tax is applied to the net taxable profits of the business.
Net taxable profits are calculated by deducting all allowable expenses from taxable income. Certain expenses are subject to specific tax limitations and calculation rules – such as client entertainment and the calculation of US depreciation of fixed assets.
The net taxable profits are subject to federal tax at a flat rate of 21%. Prior to 2017 the US Corporation Tax rate was calculated based on income bands, with a top rate of 35%.
Where a business realises a net loss for tax purposes, this is referred to as a Net Operating Loss (NOL). NOL’s can generally be carried forward indefinitely, however those realised prior to 1 January 2021 are subject to some complicated transition and limitation rules which can allow carry back to earlier tax years.
NOL’s realised after 31 December 2020 can be used to reduce the taxable profits of future tax years. However, the amount of NOL that can be used in each year is limited to 80% of that year’s taxable profits. In practice this means that a US corporation will be subject to US Corporation Tax on at least 20% of its profits each year. All unused NOL’s are carried forward to the next tax year.
2. State Corporation Tax
Each state imposes its own Corporation Tax rules and tax rates. The Corporation Tax rates vary from state to state and are generally applied in relation to the business net profits attributable to the state nexus. Some states apply a fixed minimum tax based on the gross revenue associated with the state nexus.
|Corporation Tax Rate
|New York City
|No Corporation Tax
|No Corporation Tax
* New York Corporation Tax is the minimum of 6.5% of net profits, 0.18755% of business capital or a fixed minimum amount based on gross income starting at $25 for revenue of less than $100k, and $200k for revenue in excess of $1 billion.
^ New York Corporation Tax is the minimum of 8.85% of net profits, 0.15% of business capital or a fixed minimum amount based on gross income starting at $25 for revenue of less than $100k, and $200k for revenue in excess of $1 billion.
‘” Texas Corporation Tax is calculated as 0.75% of taxable margin.
3. State Franchise Tax
In addition to corporation tax, some states charge a business a franchise tax for the privilege of doing business within its borders.
Franchise tax is separate from corporation tax and is usually calculated in relation to a corporation’s assets, shares or employees. The franchise tax is usually paid with a simple online form and can have a different due date form the corporation tax return.
Failure to pay required franchise taxes can lead to a corporation losing its ‘good standing’ status, being subject to penalties and, in certain situations, being dissolved.
|$175 – $250,000
|1 March annual
|0.1% – 0.15% of paid-in capital
|Within 60 days of year end
|$0.25 per $100 of net worth
|15th day of 4th month following end of tax year
4. State Sales & Use Tax
The Sales & Use Tax system is the closest equivalent to the UK’s VAT system. Each state will impose its own Sales & Use Tax rules and rates, and like state corporate tax, a business will be subject to these rules if it has nexus in the state.
Sales tax is a transaction tax imposes on the price paid for the purchase of tangible goods and services. Use tax is also a transaction tax and applies when a purchaser uses or consumes tangible personal property or services.
When conducting business in a state it is important to determine whether sales tax should be added to the price charged for your product or service to ensure the business is not required to pay sales tax out of net profits, and that all required registrations and tax filings are submitted on time.
For many businesses the first prompt to consider US tax will be a request to complete a Form W-8 by a US customer. From this point onwards the business should consider its ongoing operations in the US, whether it is conducting a US trade or business, whether it has created a US permanent establishment and whether it has any state nexus.
Prompt consideration of these factors can help limit the UK limited company’s exposure to US federal and state tax, and penalties related to failure to file required tax forms. However, the most severe consequence of failure to comply with US tax requirements is the denial of deductions by the IRS, which would subject the business to US Corporation Tax on a gross income basis. In practice this can lead to UK businesses which realise a net loss from US operations crystalising a US tax liability equal to 21% of gross income.
It is also important to consider the evolution of the US operations of a UK business, and plan for the most appropriate opportunity to create a US subsidiary. A US subsidiary can ringfence the US tax exposure to the operations of the subsidiary only and can make the hiring US based employees a possibility.
How we can help
Our dual-qualified team can help you navigate the choppy seas of US expansion, from ensuring you remain compliant with required federal and state tax filings, to proactively managing your US permanent establishment and state nexus exposure, to introducing our key network contacts at the right time of your expansion.
We are here to sign post the key milestones of your US expansion, help you plan accordingly and support your business as it grows into the US.
Would you like to know more?
If you would like to discuss how the above may affect you and your tax affairs, please get in touch with your usual Blick Rothenberg contact, or one of the team via thier profiles.
Personal tax is one of the most complex areas of wealth management and can significantly erode your wealth over time
Blick Rothenberg is considered to be market leaders in the taxation of non-UK domiciled individuals and offshore trusts, as well as cross-border personal taxation.
We have a strong base of clients in the UK and a broad and longstanding international focus too, acting for a large number of non-UK domiciled individuals and international families. So, we understand the complexities that US citizens face when living, working and operating businesses in the UK.
Whether you are a start-up entrepreneur, a wealthy family with complex affairs, or a business executive, our dual-qualified team of tax advisers will look after your US UK personal tax affairs as well as those of your business.
If you wish us to contact you or want to discuss your situation please complete the form on this page and one of our team will be in touch.