Chapter 3

Regulations and Requirements

Before undertaking any overseas venture, U.S. firms should be aware of foreign country agreements, licenses, host-country regulations regarding certain types of business, tax incentives, requirements, and general regulations affecting trade between the United States and the foreign country.

This chapter reviews the following topics:

Accounting and Tax Information

General Information

This chapter provides the most current and detailed information available. As tax codes, rules and regulations, and treaties are added, changed, or eliminated on a frequent and regular basis, however, please be sure to contact an appropriate and authorized agency for the most up-to-date information possible.

Taxation of U.S. Citizens Abroad

U.S. citizens and resident aliens who work or live abroad or receive certain types of foreign income fall under special categories for tax purposes and are granted special exclusions or deductions under certain circumstances. Individuals are advised to consult a tax attorney or accountant to determine whether modifications to the rules have been enacted and their effect, if any, on taxes.

Operating Abroad: U.S. Income Tax Incentives

Major U.S. accounting firms offer comprehensive tax information for U.S. corporations, small businesses, and individuals engaged in international commercial transactions. They provide detailed information on taxation of foreign operations, controlled foreign corporations, sale or liquidation of controlled foreign corporations, foreign tax credits, tax treaties, and special U.S. trade incentives, as well as tax incentives offered by host countries. Because the tax subjects are complex and rules are modified frequently, business executives and individuals are advised to consult a knowledgeable tax advisor.

Tax-Favored Export Entities

U.S. law allows for the establishment of certain entities that receive special tax benefits from the income earned through the export of qualifying goods and services. Previous laws and entities have been deemed noncompliant with World Trade Organization principles, but the interest-charge domestic international sales corporation (IC-DISC) remains one of the best means for U.S. exporters to reduce their tax expenditures. The qualification requirements and associated benefits of the export incentives are as follows: Rather than forming a foreign sales corporation (FSC), exporters may establish a domestic entity known as an Interest-Charge Domestic International Sales Corporation (IC-DISC). To qualify, a domestic corporation must derive at least 95% of its gross receipts from exporting activities and 95% of its assets must be export related. If the corporation meets these and other requirements, the IC-DISC provisions of the tax code will allow the partial deferral (versus the FSC’s exemption) of U.S. income taxes on export profits derived from a maximum of $10 million of gross receipts annually. Unlike the FSC, the IC-DISC is not subject to U.S. tax. Its shareholders however, are taxed currently. In addition, the shareholders must also pay an interest charge on the deferred tax of the IC-DISC. As with the FSC, the IC-DISC rules also provide special pricing and income-allocation techniques to maximize available tax benefits.

Operating Within a Foreign Country

If a U.S. corporation or individual establishes a foreign corporation to carry on activities abroad, its income is generally not subject to U.S. tax until the corporation pays a dividend to the U.S. shareholder. Therefore, U.S. tax on such foreign income may be deferred, even though the foreign corporation is owned entirely by a U.S. corporation or individual.

When a dividend is paid, the U.S. government will allow a credit for withholding tax imposed by the foreign country on the dividend. In the case of a U.S. corporate shareholder owning at least 10% of the foreign corporation, a credit is also allowed for all or a portion of any foreign corporate income tax imposed on the foreign corporation.

Operating Abroad Through a Branch of a U.S. Corporation, Partnership, or Joint Venture

A U.S. corporation that has foreign-source income through the operation of a branch incurs U.S. corporate taxes on that income as it is earned. If there are foreign losses, those amounts may be used to reduce its U.S. taxable income. If foreign income taxes are paid on the foreign-source income, the foreign taxes may be credited against its U.S. taxes (subject to certain limitations if foreign losses have been used to offset U.S. income). U.S. partners or joint ventures must include a share of foreign-source income in their U.S. tax returns. U.S. tax is payable on this income, but a credit is allowed for a share of foreign income taxes incurred.

S Corporations

Certain provisions of the Internal Revenue Code (IRC) allow a U.S. corporation that is owned by a small group of U.S. shareholders to elect to pay no U.S. corporate taxes. Instead, each shareholder is taxed on a share of the corporation’s income as it is earned and may deduct a share of any losses. Since the corporation is not taxed, the usual double tax burden of operating in the corporate form (i.e., the corporation is taxed and the shareholders are taxed when dividends are remitted to them) is avoided. Foreign corporate income taxes paid by such a corporation that operates abroad are allowed as credits on the shareholders’ U.S. individual tax returns.

Exemption From Gross Income for Employees Based Abroad

Self-employed U.S. individuals or U.S. employees residing in a foreign country can be exempt from U.S. income tax up to $92,900 of foreign earned income (income from the performance of personal services in the foreign country). To qualify for this exemption, the employee or self-employed individual must be a resident abroad for an entire tax year or be physically present abroad for at least 330 days during a 12-month period. An employee may also be exempt from U.S. income tax on amounts received from his or her employer to cover certain excess housing costs incurred in the foreign country. Many employers take advantage of these exemptions by reducing the compensation of their overseas employees by an amount equal to the U.S. income tax that the employees would have paid had they remained in the United States.

Foreign Tax Credit Limitation

All U.S. taxpayers are permitted to credit against their U.S. income tax liability foreign income taxes paid or accrued during the taxable year on foreign-source income. In most instances, U.S. corporate taxpayers that receive dividends from a foreign subsidiary in which they own at least 10% of the voting stock are allowed to credit the corporate income taxes paid by that subsidiary on the earnings distributed. However, there are limitations on the credit designed to ensure that the foreign tax credit claimed will not exceed the U.S. income tax payable by the U.S. taxpayers on the foreign-source income. To the extent the limitation prevents a U.S. taxpayer from crediting all the foreign income tax paid or accrued, double taxation (U.S. plus foreign) or excessive taxation of the same income may result. Due to various factors, including differences in U.S. and foreign concepts of income, it is not unusual for the amount of creditable foreign tax to be limited in a taxable year. Taxpayers unable to fully use all their available credits due to the FTC limitation may carry unused credit back 2 years and forward for 5 years.

Transfers of Property to a Foreign Corporation

When a U.S. business organizes a foreign corporation to do business abroad, it often transfers to that foreign corporation tangible property that has appreciated in value (such as equipment or foreign currency), or intangible property that will give rise to future income (such as patents or technical know-how, customer lists, etc.) necessary for conducting that business. Any such transfer must be reported to the Internal Revenue Service (IRS). The gain realized on a transfer to a subsidiary company would ordinarily not be taxed by the United States at the time of transfer. However, since the foreign corporation’s income may not be currently subject to U.S. income tax, it would be possible for that corporation to subsequently sell or use that property and avoid any U.S. income tax. To prevent such avoidance, when applied to transfers of property to a foreign corporation, the general rule is that the amount of gain or income to be earned will be recognized and subject to tax. Certain exceptions to this rule exist, including nonrecognition of gain if tangible assets transferred will be used in the active conduct of a trade or business outside the United States.

Passive Foreign Investment Company

A passive foreign investment company (PFIC) is any foreign corporation in which, for any taxable year, 75% or more of the gross income consists of passive income, or if at least 50% of the average value of the assets produce (or are held to produce) passive income. Ownership percentage by U.S. persons is not a determinant of PFIC status. A PFIC can elect to be treated as a qualified electing fund (QEF) or a nonqualified electing fund (non-QEF). A U.S. shareholder in a PFIC electing QEF status must currently include in income the pro rata share of the QEF’s net capital gain and other earnings and profits (subject to the taxpayer’s election to defer payment of tax and incur an interest charge). A U.S. shareholder in a PFIC that does not elect QEF status must pay tax and an interest charge on the deferred portion of any gain on disposition of PFIC stock and on certain distributions from the PFIC.

Passive Income: The Closely Held Foreign Corporation

As discussed previously, if a U.S. individual organizes a foreign corporation to conduct activities abroad, the income earned by that corporation will normally not be subject to U.S. income tax until the U.S. corporation pays dividends to that individual. However, if more than 50% of the corporation’s gross income is passive income (e.g., interest, dividends, etc.) and more than 50% in value or voting power of the corporation’s stock is owned by five or fewer U.S. citizens or residents, the corporation will be a Foreign Personal Holding Company. As such, the corporation’s net income will be taxed directly to its U.S. shareholders although not actually distributed to those shareholders as dividends.

Controlled Foreign Corporations

Because the income of a foreign corporation is generally not taxed by the United States until distributed as dividends to its U.S. shareholders, some taxpayers seek to shift income currently taxable by the United States to a foreign subsidiary to defer U.S. income tax. The IRC attempts to prevent this by requiring shareholders of so-called controlled foreign corporations (CFC) to pay tax currently on the following types of income earned by the CFC even though such income has not been distributed to the shareholders:

Non-Arm’s-Length Dealing With a Foreign Corporation

If a U.S. corporation deals with its foreign subsidiary in other than an arms-length fashion, the IRS may adjust the U.S. taxpayer’s income as if the parties were unrelated. Thus the arm’s-length standard requires a related taxpayer to report its income and expenses from transactions with its parent as if it were not related to its parent. (It is, therefore, extremely important that the basis for any intercompany pricing be carefully documented.)

Tax Treatment of Gains by U.S. Parent From Foreign Subsidiary

If a U.S. corporation sells or exchanges (including liquidation) stock of a foreign subsidiary that is a CFC, any gain recognized by the U.S. corporation on the stock sale will be taxable as dividend income to the extent the gain does not exceed the foreign corporation’s earnings and profits attributable to the stock that have not been previously taxed by the United States.

Bribe- and Boycott-Related Income

U.S. taxpayers who use foreign corporations to make illegal bribes or other payments to foreign officials or who participate in economic boycotts against Israel (or other designated countries) may be denied credits for foreign income taxes, deferral from U.S. tax on the foreign subsidiary’s income, and FSC benefits.

In addition to the tax implications of making illegal bribes or payments to foreign officials, there can also be serious legal consequences for individuals as well as corporations. To combat the pervasiveness of bribery in international transactions, the Organisation for Economic Co-operation and Development (OECD) has established the Anti-Bribery Convention, which provides legally binding standards to criminalize bribery of foreign public officials in international business transactions. The 34 OECD member countries, which include the United States as well as Argentina, Brazil, Bulgaria, and South Africa, have adopted the convention.

Denial of the Foreign Tax Credit With Respect to Certain Foreign Countries

In general, the foreign tax credit is denied when income is attributable to activities conducted in one of the following:

In addition, U.S. shareholders of CFCs will be taxed currently on the corporation’s income attributable to activities conducted in one of the previously described countries.

Organizations and Services

Financial/Governmental Accounting Standards Board (FASB/GASB)

These organizations establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information. FASB serves the investing public through transparent information resulting from high-quality financial reporting standards developed in an independent, private sector, and open due process. GASB establishes and improves standards of state and local government accounting and financial reporting.

Internal Revenue Service (IRS)

This government organization assists international taxpayers through a variety of services, including technical assistance, publications, and other services that can be accessed online. The IRS was recently reorganized into four divisions to better serve its clients: Wage & Investment, Small Business/Self-Employed, Large to Midsize Businesses, and Tax Exempt & Government Entities Division. For more information or for questions concerning tax status or regulations, please contact your state’s local IRS office listed on the IRS website, or at the following address:

International Tax Counsel

This division within the U.S. Department of the Treasury negotiates tax treaties, reviews and works on proposed regulations, and reviews IRS revenue rulings. The International Tax Counsel office also provides up-to-date information on international tax legislation.

Export License Assistance

General Information

Export Licensing

While it is true that only a small percentage of total U.S. exports and reexports require a license, a number of factors must be considered by a U.S. company before exporting abroad. First, it is important for a business to consider what exactly it is they are exporting. One key in determining if an export license is required is whether the item to be exported has a specific Export Control Classification Number (ECCN). All ECCNs are listed in the Commerce Control List (available on the Government Printing Office website), which serves as a quick reference for products in the following 10 categories:

If an item falls under the U.S. Department of Commerce jurisdiction and is not listed on the CCL, it is designated as Export Administration Regulation EAR99. EAR99 items normally consist of low-technology consumer goods, which do not require a license unless you plan to export to an embargoed country, to an end user of concern, or in support of a prohibited end-use. In such cases, you may be required to obtain a license. In the event a license to export is required, the exporter must apply to the Bureau of Industry and Security (BIS) for an export license.

Currently, exports to embargoed countries and those designated as supporting terrorist activities such as Cuba, Iran, North Korea, Northern Sudan, and Syria are more restricted. Restrictions vary from country to country, but generally reflect U.S. government policy toward individual countries. In addition, if the individual or organization receiving the item is prohibited from receiving U.S. exports, a license will be required. As such, to ensure the end user is not of concern, exporters should reference the (a) Entity List, (b) Treasury Department Specially Designated Nationals and Blocked Persons List, (c) the Unverified List, and (d) the Denied Persons List.¹

Licensing Technology to a Foreign User

If a U.S. business decides not to operate abroad but to make its technology available to a foreign user through licensing, royalties or other fees received for the use of the technology may be subject to withholding by the foreign country on the gross amount of the fee. Generally, when such a withholding is made, it is creditable against the U.S. income tax payable upon the fee. An income tax treaty between the U.S. and the foreign country may reduce or eliminate this withholding.

For some U.S. businesses that have neither the desire nor the capacity to set up operations overseas, licensing technology may provide a useful alternative. However, it may be best from a business standpoint to establish operations abroad. In that case, significantly different tax considerations come into play. Licensing not only may create competitors but also may restrict market access.

Department of Commerce (DOC)

A Basic Guide to Exporting and U.S. Export Administration Regulations

This publication of the International Trade Administration is obtainable from the U.S. Government Printing Office to assist businesses in developing export strategies, finding economic market research, shipping overseas, completing export documentation, responding to overseas inquiries, and taking advantage of available government export-assistance programs.

Export Programs Guide: A Business Guide to Federal Export Assistance

The Export Programs Guide has been the most comprehensive guide to federal programs that assist U.S. exporters. Released in 2009, this edition offers detailed descriptions of more than 100 programs offered by 20 different federal agencies. These programs include export counseling programs, information on trade promotion events, export financing programs, sources of industry- and country-specific information and assistance, and information on export controls and licenses. The PDF guide is available for free download at their web address.

U.S. Trade Representative (USTR)

Bilateral Investment Treaty (BIT)

These treaties are reciprocal agreements between the U.S. government and a foreign government that outline the treatment of investors in the two countries. These treaties, ratified by the Senate, create an international obligation for the United States and the foreign treaty partner, thus superseding domestic law. The U.S. government seeks to negotiate BITs that contain the following major elements:

The Trade Compliance Center maintains an online list of BITs currently in force at their web address.

Other

Treaties and Other International Acts Series

This publication contains the texts of at least 200 treaties entered into by the United States with other nations. It is published and issued in an indeterminate period. Subscription costs $89.

OECD Factbook

Published annually by the Organisation for Economic Co-operation and Development (OECD), this best-selling title provides a global overview of today’s major economic, social, and environmental indicators in a range of user-friendly formats. The OECD Factbook can be purchased from the OECD Online Bookshop for $70 and covers more than 100 indicators in a range of areas including population, economic production, foreign trade and investment, energy, labor force, public finances, and so forth.

OECD Economic Surveys—Country Index

The Economic Survey is published roughly every 2 years for each of the 34 OECD countries. It identifies the main economic challenges faced by each country and provides policy options to meet them. To access the list of surveys for a particular country, please see the website’s link.

Organizations and Services

Department of Commerce

Office of Services

This division of the DOC provides counseling and advice on U.S. and foreign country laws, regulations, and practices affecting international trade and investment. It is further subdivided into the Office of Service Industries, Office of Financial Service Industries, and the Office of Travel and Tourism Industries. Staff members offer information and help U.S. firms research laws on taxation; antitrust and patent and trademark rights; licensing patents; foreign agents, distributors, and joint ventures; product liability; and other issues related to exporting and international investment.

Department of State

Commercial and Business Affairs (CBA)

This office is the point of contact in the U.S. Department of State for U.S. companies requiring assistance with international business. CBA works directly with U.S. business representatives to help them tap into the worldwide resources of the department. CBA creates a dynamic partnership with U.S. businesses by championing U.S. business interests overseas with advocacy, troubleshooting, and market access support; articulating the U.S. business community perspective in foreign policy making and management; engaging business leaders on international issues that affect them; and working with international and U.S. organizations, opinion leaders, and other stakeholders to advance U.S. commercial and business interests in the global marketplace.

Office of International Intellectual Property Enforcement (IPE)

The IPE promotes American and global innovation by advocating for the effective protection and enforcement of intellectual property rights around the world. The IPE team works with economic officers at the State Department’s embassies, consulates, and missions to ensure that the interests of American intellectual property rights holders have global representation. The IPE also serves to demonstrate the integral role of intellectual property rights protection in the development of the global economy.

National Marine Fisheries Services (NMFS)

Trade and Commercial Services

This branch of the NMFS addresses trade problems affecting U.S. fishery exports. Domestic and international issues include market access, standards development and application, inspection of U.S. exports, technological trade barriers, traditional industry development, product utilization, and other issues related to industry competitiveness. It also prioritizes industry trade issues in order to improve access to foreign markets and enhance the competitive position of the U.S. fishing industry. These services also develop and implement trade strategy, and negotiate positions in response to industry needs, by representing the assistant administrator of the NMFS in trade negotiations with other U.S. government agencies and foreign governments.

United Nations (UN)

United Nations Commission on International Trade Law (UNCITRAL)

UNCITRAL is the core legal body within the UN system in the field of international trade law. UNCITRAL was tasked by the UN General Assembly to further the progressive harmonization and unification of the law of international trade. In order to increase these opportunities worldwide, UNCITRAL formulates modern, fair, and harmonized rules on commercial transactions including

Organizations and Services

United States International Trade Commission (USITC)

Trade Remedy Assistance Office

This office was established as a separate division of the USITC to assist eligible small businesses in preparing petitions to the ITC to halt unfair trade practices such as the dumping of foreign goods at below-market prices, as well as foreign import restrictions and export subsidies. This office works closely with the U.S. Department of Commerce, the U.S. Customs Service, the U.S. Trade Representative, and the U.S. Department of Labor to provide technical assistance to firms seeking relief under U.S. trade laws. Legal services assist small companies with filing petitions.

National Institute of Standards and Technology (NIST)

Laws and Metric Group

Standard shipping practices for shipping products or providing quotes for foreign customers designate that products must be denominated in metric standards. The Laws and Metric Group of the Weight and Measures Division provides exporters with guidance and assistance on foreign metric import regulations.

National Center for Standards and Certification Information (NCSCI)

This organization is the central depository and inquiry point for standards information in the United States. NCSCI responds to over 5,000 individual inquiries annually on identification and source availability of standards. NCSCI provides research services on standards, technical regulations, and conformity assessment procedures for nonagricultural products.

Small Business Association (SBA)

Export Legal Assistance Network (ELAN)

This organization provides free initial consultations to small companies on the legal aspects of exporting through an arrangement with the Federal Bar Association (FBA). Qualified attorneys from the International Law Council of the FBA provide advice for companies engaged in the export industry.

U.S. Department of Agriculture (USDA)

Agricultural Marketing Service (AMS)

This service of the USDA provides a voluntary food-quality certification service to help U.S. exporters meet importers’ specifications. The service is provided on a user-fee basis. To apply for this service, a copy of the contract specifications must be submitted to AMS in advance. AMS reviews the contracts and works with the companies to develop written specifications that can be certified.

Animal and Plant Health Inspection Service (APHIS)

This division provides U.S. agricultural exporters with information concerning foreign import requirements for livestock and fresh vegetables. APHIS will also negotiate with foreign agricultural offices regarding the entry requirements for U.S. agricultural products. For a complete listing of departmental contact information, please refer to the following web address.

Food Safety and Inspection Service (FSIS)

This service supplies information regarding foreign import regulations for meat and poultry. FSIS also inspects meat and poultry products to ensure that they meet both U.S. and foreign standards.

Grain Inspection, Packers and Stockyards Administration (GIPSA)

GIPSA facilitates the marketing of livestock, poultry, meat, cereals, oilseeds, and related agricultural products, and promotes fair and competitive trading practices for the overall benefit of consumers and American agriculture. GIPSA is part of USDA’s Marketing and Regulatory Programs, and works to ensure a productive and competitive global marketplace for U.S. agricultural products. GIPSA also helps ensure a fair and competitive marketing system for all involved in the merchandising of grain and related products, livestock, meat, and poultry.

International Regulations and Standards Division (IRSD)

IRSD is responsible for coordinating with U.S. regulatory agencies and the U.S. food and agricultural industry U.S. government comments pertaining to foreign Sanitary and Phytosanitary (SPS) measures notified to the WTO in the development of international standards.

Other

American National Standards Institute (ANSI)

This organization represents the interests of over 1,000 companies, organizations, government agencies, and international members. ANSI facilitates development by ensuring consensus, due process, and openness among its qualified groups. ANSI also promotes the use of U.S. standards internationally and encourages the adoption of international standards as national standards when these meet the needs of the user community.

THOMAS

The THOMAS World Wide Web system provides free access to legislative information including bills, resolutions, activity in congress, committee information, treaties, and other government resources. Enhancements in the types of legislative data available, as well as in search and display capabilities, are continually being updated.

International Organization for Standardization (ISO)

This worldwide federation of national standards bodies from some 130 countries is a nongovernmental organization established in 1947. The mission of ISO is to promote the development of standardization and related activities in the world to facilitate the international exchange of goods and services and to develop cooperation in the spheres of intellectual, scientific, technological, and economic activity. ISO’s work results in international agreements that are published as international standards.