U.S. Based Parent Corporations With Foreign Branch Operations Need To Take Into Account Potential Application Of The Overall Foreign And Domestic Loss Rules

For U.S. taxpayers planning to engage in business operations in foreign countries, especially in start-up type situations, consideration must be given as to what are the potential tax consequences, including timing differences, for reporting built-in losses and anticipated foreign losses from operations overseas. The melding of the expected tax impacts are also important in projecting the effective rate of tax for GAAP or foreign financial accounting purposes. For example a loss incurred by a wholly owned foreign-based subsidiary is frequently required to be consolidated with income of other controlled subsidiaries or affiliates in computing consolidated financial income of the U.S. parent corporation even if such foreign losses cannot be currently used to reduce the U.S. parent's taxable income. A loss which is realized by a foreign based affiliate that is not deductible in such year for U.S. income tax purposes will still be a factor in increasing the overall effective tax rate of the consolidated group (for financial accounting purposes).

Example. US Parent Corp. owns four foreign based subsidiaries which all meet the definition of a foreign controlled foreign corporation. Three of the foreign based CFCs have taxable income for 2013 of $300x (all of which is Subpart F income) while the fourth CFC for the same year realizes a taxable loss of $500x. Overall, the foreign based CFCs have a book loss for 2013 of ($200). However, the CFC loss with respect to the fourth CFC cannot be currently used to reduce the CFC income of the other three CFCs or otherwise reduce the US Parent Corp's worldwide income. Thus, the effective tax rate with respect to foreign operations will be as high as 35% (U.S. federal) on the $300x of Subpart F income.

Use of Branch Operations For Conducting Business Operations Overseas

Because of the potential lock-in effect of foreign source losses from controlled foreign subsidiaries, consideration should be given to operating a foreign base as a "branch" which can be accomplished, for example, by conducting foreign based operations through a hybrid ("eligible entity" under the check-the-box regulations) entity or pass thru single member limited liability company.

Of course, consideration must first be given to whether the prior and current activities of the foreign branch will give rise to income and VAT tax in the foreign jurisdictions in which the branch is engaged in business operations. Any applicable income tax convention must also be taken into account is assessing the potential tax obligations of a foreign based operation. See, e.g., 2006 U.S. Model Income Tax Treaty for exceptions to the permanent establishment rules for business operations conducted in the other Contracting State. Such exceptions include: (1) maintenance of a stock of goods or merchandise solely for display, storage, or delivery; (2) maintenance of a stock of goods for processing by another enterprise; (3) maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or collecting of information for the business; (4) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary...