In the lifecycle of a multinational company, there are times when it makes sense to downsize the business or its global footprint. Whether your business is contracting due to planned or unforeseen circumstances—or keeping up with market trends by discontinuing operations—there are numerous considerations to take into account. While some considerations are practical, there are also international tax planning opportunities that can help facilitate a seamless transition, such as:
- Cash-repatriation planning
- Employees versus independent contractors
- Permanent establishment risks
- Foreign-derived intangible income
- Transfer pricing
When an operation has been successful or there are transfer-pricing strategies that haven’t yet been optimized, cash has likely built up in a foreign jurisdiction. The question of how and when to repatriate this cash carries with it financial, operational, and tax considerations, but it’s often an afterthought in the wake of a discontinued operation.
There are various repatriation options for multinational companies, and cash can return to the headquarter company via the following:
- Related-party loans
- Management fees
In the context of discontinued operations, companies may want to consider dividends and management fees to reduce cash in the foreign jurisdiction prior to liquidation. For example, if a foreign corporation’s earnings have already been taxed in the United States due to a US international tax provision, a dividend may be treated as a tax-free distribution rather than a taxable dividend. In the context of a discontinued operation, however, it’s important to consider whether dividends may be limited by local law (for instance, dividends may not be legally allowed if there are accumulated losses in a jurisdiction).
Charging a foreign subsidiary company a management fee for services provided by headquarters is another option for bringing cash back to the United States.
Considering these options through the lens of a contracting operation presents opportunities for planning around the withholding taxes that may occur in the foreign jurisdiction if a dividend is paid. Transfer pricing can also help appropriately determine a management fee, if that route is taken for cash repatriation.
Employees Versus Independent Contractors
As operations wind down in a specific jurisdiction, there may be lasting activity that can be handled by a part-time workforce or employees with limited functions. While these individuals can be employees or contractors, care should be taken to manage global payroll risk—especially if the local office that handled human resources and payroll issues has been closed.
Multinational companies will want to consider whether employees or contractors remaining in a jurisdiction trigger an income tax presence. This could create an unanticipated expense while activities are decreased. Evaluating the functions of the remaining workforce in conjunction with income-tax treaties and local laws can help make this determination, which can in turn mitigate risk related to employees and contractors remaining in place while operations wind down.
Permanent Establishment Risk
In the same way an expanding multinational company needs to consider its foreign country activity and the risk that a taxable presence—also known as a permanent establishment—is created locally, a contracting company can use the same strategies to manage risk when operations are slowing.
Consider a multinational company with a subsidiary in Europe that services a local market. When market demand slows and a decision is made to close the European subsidiary, it’s necessary to determine if the US company can continue to service any remaining clients or if those clients would expose the US company to taxation locally. Each situation is unique and should be analyzed in conjunction with the business decision to discontinue operations.
It’s important to evaluate the remaining operations in a jurisdiction against income tax treaties or local laws to determine if a taxable presence is likely. In order to serve remaining markets, companies should work with their tax and business advisors to review what activities would be allowed under the treaty or local law without triggering an income tax presence.
Foreign-Derived Intangible Income (FDII)
Beginning in 2018, US C corporations that export goods or services are eligible for a 37.5% (decreasing to 21.875% in 2026) FDII deduction. The FDII deduction is an export incentive on sales made or services provided to foreign persons that’s meant to provide a preferential tax rate to US exporters. Foreign income that’s earned offshore isn’t eligible for the deduction, which means the global footprint of many US multinational companies limits their ability to claim an FDII deduction. This provides US companies that onshore business functions the opportunity to take advantage of the FDII export incentive.
US exporters that onshore business activity to simplify operations and reduce duplicative costs should determine whether this also results in an FDII benefit. The starting point for this analysis is to determine the extent to which the value of exports is produced in the United States.
Unfortunately, as with many areas of government policy, there’s uncertainty around the future of the FDII export incentive. The current US administration has proposed a number of tax law changes, which include modifying or eliminating FDII. US exporters expect clarity soon in this crucial area, which will help with business decisions regarding export incentives.
If a business is restructuring its global operations to rationalize manufacturing or performing services in fewer locations, the changing footprint of functions, risks, and assets could imply different transfer-pricing relationships.
As the value change evolves, participants in that chain may command higher or lower levels of remuneration depending on changes in their contribution—and even if a company is completely exiting a country, residual transfer-pricing risk could remain from past years.
If the exit is being motivated by poor performance, careful consideration should be given to the preparation of documentation that casts the company in a favorable light. This would help reduce the risk that an auditor would claim the performance challenges were caused by incorrect transfer pricing.
It’s essential to identify and plan for these transfer-pricing issues and take the following steps:
- Implement a strategy to keep books and records in accordance with the revised plan
- Provide documentation to support remaining related-party transactions
Transfer pricing can be used to mitigate the risk of changing activity levels as well as plan for decreasing operations by moving more cash to the United States.
We’re Here to Help
For more information about how to take advantage of tax planning opportunities as your multinational company prepares to downsize, contact your Moss Adams professional.