In an effort to simplify how business is conducted (and taxes are assessed), many national governments enter into legal agreements designed to clarify the law and mitigate double taxation. The ultimate goal of these agreements is to encourage economic activity and investment between countries. These agreements are called Tax Treaties.
The United States has tax treaties with 68 different countries. A tax treaty is primarily used to clarify the following questions –
- When can a country impose and collect tax on a foreign business?
- What rate of tax is to be imposed?
Businesses whose home countries have tax treaties with the US have clear guidelines to follow when expanding to the US. Countries that do not have tax treaties with the US must operate according to the standard US regulations and filing thresholds. The tax rates imposed on businesses from countries without tax treaties are less favorable. This does not mean Colombian companies shouldn’t do business in the US, but that extra planning must be taken, as mistakes and mis-classifications are more expensive as a business from a country without a US tax treaty.
The subsequent sections refer to the US tax rules applicable to Colombian based businesses expanding operations to the US
Permanent Establishment (PE) – When can a country impose tax?
If a company established in Colombia is doing business in the United States both the United States and Colombia have the legal right to impose tax. This is true whether there is a tax treaty or not.
Doing business in a country = Permanent Establishment (PE).
The thresholds for determining PE for businesses from countries with no US tax treaty are lower and there are no exceptions to the rules. If a Colombian based company is doing any of the following in the US, PE would be triggered. Does the company:
- Have an office located in the US?
- Have employees located in the US?
- Have sales people in the US?
- Negotiate contracts with US clients while in the US?
- Send technicians to the US to service clients?
The PE laws are subject to interpretation, but generally if a business has a physical connection to the US, the US government will impose tax on profits. For a Colombian S.A. (Sociedad Anónima) the tax would include the US base 21% corporate tax, plus the branch profits tax which is 30%. The branch profits tax applies to foreign corporations doing business in the US
All these taxes on top of the 34% tax in Colombia make doing business unsustainable. This is a global 85% tax rate.
There is a simple solution to avoid this level of taxation. The Colombian company would open a subsidiary or separate entity in the US Usually the US company would be set up as a C-Corporation but this isn’t always the best option.
This would stop the direct double taxation and allow each country to tax the income earned only by the entity established in its borders. The CO company can ship products to the US company or provide remote services for the clients of the US company, it just cannot do any of the activities that would trigger PE.
Once a US subsidiary is established, the manner in which the US and CO entities do business must be reviewed. US and CO related entities can do business together, however many types of transactions are subject to US withholding.
Tax Withholding – What rate of tax is imposed?
The most prevalent US law which mandates tax withholding for payments made from US persons to Colombian companies is the Foreign Account Tax Compliance Act or FATCA. FATCA requires a US person (or company) making specific types of payments remit a percentage to the US government.
If the rate of withholding is higher than the actual tax that is assessed, the foreign person can file a tax return at the end of the year to claim a refund for the difference.
To reiterate, FATCA requires tax withholding for certain payments from US persons to non-US persons. FATCA impacts most non-US entities which are receiving US source income. The base rate of withholding is a flat 30%.
Payments that are “Fixed Determinable Annual or Periodic” would fall under the FATCA regime. The most common payments are Interest, Dividends, Royalties and Capital Gains. A US company paying a Colombian company any of these types of payments must send 30% of the payment to the IRS to comply with FATCA withholding rules. If the withholding payment is sent late or not at all, the US company is liable for the full amount in addition to expensive penalties and interest.
The withholding rates with tax-treaty countries are usually much lower.
Example – a Colombian company licenses out its software to a US business. The US business must remit 30% of the royalty payments to the IRS. If the company was from Italy instead of Colombia, the withholding would be 8%.
Example 2 – A US subsidiary of a Colombian company has record profits and wants to pay out a dividend. The US business must remit 30% of the dividend payment to the IRS. If the company was from Mexico instead of Colombia, this tax would be 5%.
“Bonus” – Death Tax Treaties
Completely separate from income tax treaties there exist death (estate) tax treaties. The US has death tax treaties with only 15 countries; Colombia is not one of these countries.
The US estate tax is assessed on the transfer of a person’s assets to their beneficiaries after death. A person is subject to the US estate tax rules only if they were a US citizen or resident, or had US based assets.
The estate tax exemption for a non-resident is $60,000 and the estate tax rate is approximately 40%. A US non-resident will only pay taxes on US based assets.
US citizens and residents have an estate tax exemption of $11,180,000 USD, so only estates in excess of this amount will have to concern themselves with estate taxes.
Generally speaking, the benefit of the death tax treaty is that the large $11 million USD exemption for residents is also extended to non-residents. This eliminates the estate tax for many people that would otherwise be subject to this tax.
The best way to illustrate this tax is with an example.
Juan Carlos is a Colombian citizen who owns a vacation home in Miami with a fair market value of $750,000. There is no mortgage. Juan has an estate of $7,500,000 back in Colombia. Unfortunately Juan dies.
$750,000 Market value of the vacation home
-$60,000 Estate tax exemption
$640,000 Taxable US Estate
40% Estate Tax Rate
$256,000 US Estate Tax Liability.
In the exact same scenario, if Juan Carlos was a citizen of Canada, he would have no estate tax liability in the US. This is because the US and Canada have a death tax treaty and Juan can utilize the $11,180,000 US estate tax exemption.
What this means
It is easy to see that tax treaties are beneficial for international business owners and investors. These agreements provide clear guidelines and reduce the withholding required on FATCA transactions between related parties.
All said, the lack of a tax treaty should not deter Colombians from doing business in the US, it only requires forethought and additional planning. Businesses from countries with and without tax treaties have the same opportunities to be successful; some just have it a bit easier.
Jim Baker CPA is a managing partner of Mata & Baker Tax Consultants, P.A. Mata & Baker is a boutique CPA firm with offices in Coral Gables and Fort Lauderdale specializing in multi-jurisdictional taxation issues for businesses, investors, and individuals. The firm is staffed with multilingual accountants, attorneys, enrolled agents, and other practitioners, and is equipped to service its international client base in English, Spanish, and Portuguese. In addition to domestic and international tax planning and preparation, the firm’s professional services also include accounting for small and mid-size businesses and Tax Dispute Resolution.