SINGLE MEMBER LLCs WITH A FOREIGN PARENT
Under the LLC legal structure for U.S. companies, there are several corporate structures available to the U.S. taxpayer that include the Partnership structure (Form 1065), C Corporation structure (Form 1120), S Corporation structure (Form 1120S), and the Disregarded entity structure (Form filed is dependent upon the type of Owner).The default tax structure for LLCs with more than one owner is a Partnership. With this structure, the entity is required to file Form 1065 to pass through the net taxable income to each partner of the company. The members of the LLC can elect out of the Partnership tax structure by filing Form 8832 (Entity Classification Election) to choose the C Corporation structure subject to corporate tax, or file Form 2553 (Election by a Small Business Corporation) to be an S Corporation, where the net taxable income will pass through to the shareholders, similar to the Partnership structure.
The default tax structure for a Single Member LLC(“SMLLC”) is a Disregarded entity, an entity that is not recognized as an entity separate from its owner. Therefore, all of the activity of this entity is seen as a division, or branch of the owner and thus, the net taxable income will be reported on the owner’s tax return (Form 1040 if Individual, Form 1120 if Corporation).
If the sole member of the LLC is a Foreign entity, the disregarded entity will be seen as a branch of the Foreign company. If the Foreign company is eligible for treaty benefits, the Permanent Establishment(“PE”) requirements would apply to determine whether there is a U.S. tax liability. Upon review of the Income Tax Treaty between the SMLLC foreign member and the U.S., together with discussions with the SMLLC, it should be determined whether the SMLLC will have a PE in the U.S. Consequently, any income earned by the SMLLC will be considered to be income for its foreign parent company that will be effectively connected to a U.S. trade or business.
Foreign corporations and their U.S. branches (and partnerships) are subject to U.S. tax only on their income that is effectively connected to a U.S. trade or business. Thus, for federal tax purposes, the Foreign parent company will be considered doing business in the United States under its Permanent Establishment with its SMLLC, and will have to file Form 1120-F (Income Tax Return of a Foreign Corporation) and be subject to the corporate tax rates applicable to U.S. corporations filing Form 1120.
However, since the SMLLC is seen as a branch of the foreign parent, doing business in the U.S., the branch is also subject to a branch profits tax of 30% on any profits from the branch that are remitted to the parent, and a withholding tax of up to 30% on any interest, dividends, rents and royalty income payments made to the foreign parent (tax rates may be lowered based upon Income Tax Treaty with U.S.).
With a branch structure, there is also risk of double taxation from both the U.S. tax system and the foreign parent’s country tax system. For example, in a situation where the branch incurs losses, the losses can be offset against the foreign parent’s profits. In the reverse situation where the branch is profitable, the U.S. profits will be subject to tax in the home country of the foreign parent.
The foreign parent may also expose a disproportionate share of its profits to a higher U.S. tax rate since attributing the profits to branch activities requires arm’s length consideration. There is additional risk that intangibles such as intellectual property and brand identity may build up in the U.S. over time. This could give rise to larger U.S. tax liabilities in the longer term as the group becomes more successful in the U.S. marketplace because these intangibles would necessitate attributing more of the profits to the branch.
The best way for the SMLLC to avoid all the inherent risks of the Foreign branch structure as described above, is the election to be taxed as a C Corporation by filing Form 8832. The C Corporate status would make the SMLLC a separate legal identity distinct from the parent company, classifying it as a U.S. Subsidiary of the foreign parent. The profits earned by the U.S. subsidiary of the foreign parent would be subject to tax in the U.S. up to 35%. Repatriation of profits by the U.S. subsidiary to the foreign parent would be subject to withholding tax of up to 30%. However, the tax rate for the U.S. Subsidiary can be reduced based upon the Income Tax Treaty between the U.S. and the country of the foreign parent.
Finally, for tax planning purposes, it should be determined whether the SMLLC will invest in realty property such as land, buildings, and land improvements, in the U.S. and if so, how much. A significant level of realty property owned by the SMLLC (i.e. greater than 50% of the company’s assets) may have tax consequences to the foreign parent, per the Foreign Investment in Real Property Tax Act (“FIRPTA”), if the foreign parent ever decides to sell its interest in the SMLLC.