International Business
Transactions
There are several ways to enter
a foreign market. One way to enter a foreign market
is to export directly through agents and distributors
or make direct sales to customers. Another method
is to grant a license to a company abroad to manufacture
the goods or provide services. Yet another way could
be to invest directly by establishing a manufacturing
plant or to invest indirectly by establishing a joint
venture. However, before a company makes a choice
it must consider many factors such as:
- How the company will
sell its products abroad
- What business forms
exist to conduct business abroad and the
differences between those forms
- How those differences
affect your choices
These factors are critical for entry strategy as well
as understanding organizational and tax implications
since in some countries like India the limited liability
companies (LLC) structure does not exist or taxable
in certain countries but are disregarded in other
countries for tax purposes, such as United States.
Similarly, numerous other differences could sway the
decision to choose one form over another. For example,
in some countries such as India, a foreign investor
cannot set up a partnership or proprietorship, but
a non-resident Indian can invest in a partnership
or sole proprietorship on a non-repatriation basis.
In essence, it is critical to evaluate both the organizational
as well as tax concerns.
Organizational Considerations
Options for a presence abroad consist of a liaison
office, a branch office, or a subsidiary:
- A liaison office is not a separate entity. It cannot
engage in profit-making activities. More importantly,
it can only engage in limited activities such as conducting
market research or promoting the products of a U.S.
company.
- A branch office, even though not a separate entity,
can engage in profit-making activities as well as
all other types of activities.
- A subsidiary might be a better route if limited
liability is an overriding concern. In any case, a
company must initially determine what type of subsidiary
a company can form, such as wholly owned or partially
owned, and what activities are permitted within that
structure form.
Wholly Owned Operations
Wholly owed subsidiary is a foreign company that is
100% owned and controlled by a U.S. company as long
as the foreign country does not place any restrictions
on foreign ownership. However, establishing a wholly
owned operation requires a substantial financial commitment.
Partially Owned Operations
A company can expand using licensing, franchise, or
a joint venture.
- A licensing agreement grants the right to use an
owner’s assets for a fee. This type of agreement could
be for the use of land or the right to use patents
for a given period. An owner can grant a license to
one person or more than one, depending on supply and
demand for the item. The advantages of licensing agreements
are that such arrangements require very little capital
and the entry into a foreign market is fast. The disadvantages
are that profits are limited and a U.S. company has
little control over foreign operations.
- A franchise agreement, on the other hand, offers
the franchiser more control because the franchisee
sells goods or services supplied by the franchiser.
The franchiser provides the marketing plans, management
guidance, and training, which is not available in
other organizational forms. However, this is long
time commitment. The forms of franchising are product/trade
name franchising and business format franchising.
The advantage for the franchisor is that it is a good
way to expand into a foreign market with little capital
because this method allows a franchisor and a franchisee
to combine their skills, experience, and financial
resources.
- A joint venture, on the other hand, is business
form chosen when two or more partners have unique
resources to contribute that would enhance the likelihood
of success of the venture. Because the goals for a
joint venture vary, it is critical to understand the
advantages and disadvantages of forming a particular
type of joint venture. The advantages are that this
form provides access to resources as well as endorsement
of the product or services in a foreign market. The
disadvantages are that the joint venture can be difficult
to manage and/or represents only a short-term solution,
depending on the circumstances.
Tax Considerations
It is critical for companies doing business abroad
to understand tax considerations they are subject
taxation on their worldwide income. There are many
anti-avoidance provisions that permit companies to
defer taxation such as foreign tax credits or foreign
sales corporations. In addition to understanding anti-avoidance
issues there are provisions such intercompany pricing,
which permit the Secretary of Treasury to reallocate
Income and expenses between entities to avoid tax
evasion. Finally, it is necessary to understand certain
tax treaties among counties as well.
Foreign Tax Credits
American corporations and citizens are taxed on their
worldwide income, which means income from foreign
sources is taxed by foreign jurisdiction and the United
States. As a result, some corporations and citizens
are taxed twice. Foreign tax credit provisions minimize
the effect of double taxation by permitting U.S. corporations
and citizens to offset foreign income taxes paid against
their U.S. income tax liability.
Foreign Sales Corporations
A Foreign Sales Corporation (FSC) is a corporation
that sells products manufactured in the United States
to be used outside of the United States. A FSC can
buy or sell the U.S. made products itself or it can
be an agent to facilitate the transaction. However,
to qualify as a FSC for tax purposes there are rigorous
requirements that such entities must meet such as
a corporation organized in a foreign jurisdiction
would need to meet or the number of shareholders
cannot be more than 25.
Intercompany Pricing
Although intercompany pricing is not an anti-avoidance
provision, it is critical that companies understand
this provision because Section 482 permits the Secretary
of the Treasury to allocate Income and expenses between
entities to properly reflect the Income of the entities.
Export and Import Procedures
Once an entrepreneur identifies a product to export,
how does the product reach the foreign market? The
next question is does the entrepreneur sell the product
to a middleman or does it sell to an end user? Regardless
of the method a company uses to export, are there
foreign requirements that an exporter must understand
before the exporter even develops the product, such
as labeling requirements, packing requirements, or
customs laws? Are there any licenses or tax issues
involved that an exporter must comply with so that
the shipment is not confiscated? There are endless
issues that exporters need to consider in order to
successfully export. To understand issues on this
topic, review the section Basics of Export and Import
Procedures e.g. Letter of Credit
