Without careful consideration and advice, the complexity of US/UK cross-border tax rules could see more of your hard-earned money go straight to the pockets of the taxman!
The case study below includes examples of how we helped our client. It includes advice on four key areas of US tax:
- Form 8832 is the entity classification election, known as the “check-the-box” election.
- Controlled Foreign Corporation (CFC) rules, including, Subpart F anti-avoidance rules.
- Passive foreign investment company (PFICs) rules and tax treatment.
- Global Intangible Low Taxed Income (GILTI).
In order to provide you with some background, here’s a case study about a client of ours who came across this very situation.
Larry is a UK resident US citizen and is a sole director and shareholder of a small business. The business was set up as a UK limited company, which completed financial accounts and Form CT600, paying UK Corporation Tax at a rate of 19%. He had heard about the complications US citizens can face when they are owners of foreign corporations, and so came to Buzzacott for specialist advice.
In the US, the limited company is treated as a corporate entity, much like the UK, and in general you are only personally taxed on the dividend distributions from the company, assuming you don’t take a salary. Although, since 2018 there has also been a potential GILTI tax to consider too. GILTI tax is an additional tax on US owners of foreign companies. See the GILTI summary later on. There is scope in the US to make a ‘check the box’ election on Form 8832 which allows you to change the classification of the business from that of a corporation to a disregarded entity. The change in classification would result in the net income from the business being subject to US taxation on Schedule C of your personal tax return and taxed at your ordinary rate of Income Tax, as if you were self-employed.
Case study: Should I ‘check the box’?
In order for Larry to make an informed decision as to whether or not it would be beneficial for him to ‘check the box’, we provided him with projective and comparative calculations based on his expected future revenue income, as well as cash extraction needs. We also took into consideration the US and UK tax implications on the exit strategy of the company and analysed his personal tax position, specifically his use of foreign tax credits, and provided Larry with a detailed report of our findings. Practical practical guidance, such as making the company year-end on 31 December to tie it up with the US tax year end, was also given.
Our tailored report enabled Larry to make an informed decision regarding the most suitable method of reporting the UK Limited company in the US. For Larry, this meant that the ‘check the box’ election was the most appropriate course of action.
As well as the potential tax savings, Larry’s decision also took into consideration the burden of additional compliance costs when reporting the UK limited company. We recommended the one off filing of Form 8832 ‘Entity classification form’ (‘check the box’) , and the yearly reporting of Form 8858 ‘Information return of US person with respect to foreign disregarded entities’, which is essentially a simplified version of Form 5471.
The change in classification of the entity also removed the need to worry about any complex PFIC ‘Passive foreign investment company’ (PFIC), Subpart F Income Tax and GILTI tax rules (*see below for more information of PFICs, Subpart F and GILTI).
The exit strategy from the company was a key element in the decision making as the client wanted to retain the benefit of the Entrepreneurs’ Relief for capital gains purposes in the UK. This is the reduced Capital Gains Tax rate of 10%, which would normally be irrelevant given the US long-term Capital Gains Tax rate of 20% and the additional 3.8% Net Investment Income Tax (NIIT) potentially due. The “check-the box” strategy could potentially result in no US Capital Gains tax due, therefore retaining the benefit of a 10% tax rate on the disposal of the business.
We believe our straightforward report took on a holistic approach, taking in to consideration the tax consequences for the life of the company, and gave a well-rounded and simplified account of the potential results by comparing the various routes our client could take. This format helped eliminate any unneccessary stress and ultimately made the decision making process simpler and more efficient.
No matter what our clients come to us with, we take the time to fully understand their current position and goals and therefore tailor our advice specifically to their needs.
More information on…
In general, should you own greater than 50% of the shares of the limited company, you may be subject to Subpart F rules. This could apply if the limited company received the following types of income: dividends, interest, rent and royalties, to name a few. It could also apply to income from personal service contracts where the corporation does not designate who performs the services. The Internal Revenue Service (IRS) would tax the US person on their proportional share of the Subpart F income earned by the CFC, regardless whether this has been distributed to them.
Should the US owner own less than 50% of the shares or voting rights (directly, indirectly and constructively) then the above Subpart F rules would not be a problem. However, there is a risk that a Limited company in this situation could be treated as a PFIC if there is was no “check the box election” made. A limited company would satisfy this criterion if at least 75% of its income or 50% of its assets produce either passive income or no income. For US owners of PFIC stock, a punitive tax treatment applies when there are either distributions of dividends or disposals of PFIC stock for a capital gain. Additionally, the PFIC would have to be reported year on year on Form 8621, ‘Information return by a shareholder of a PFIC’, which would incur further costs.
As a result of the Tax Cuts & Jobs Act, US owners of foreign companies will need to consider the implications of the one-off transition tax as well as ongoing Global Intangible Low-Taxed Income (“GILTI”) tax. The transition tax is a one-off tax on the accumulated earnings and profits so it will not be a consideration for US individuals setting up new businesses. GILTI is the US shareholder’s pro-rata share of net income from a controlled foreign corporation (CFC), less a 10% deduction for depreciation on tangible assets. It is charged to tax at 37% for a US individual and neither the IRC s250 deduction nor foreign tax credits apply against the tax. Potentially the global tax bill could be more than 80% when considering UK corporation tax, GILTI tax, and UK income tax on dividends. Some solutions could be to elect for the company to be transparent (making a check-the-box election), or making a s962 election to elect for the shareholder to be treated as a US company. However, it will depend on each individual’s circumstances as to what election to make, and there could be other mitigation techniques to avoid the GILTI tax issues.
The full Stepping Stones series can be found here.