S corporations in the international setting.

• Author: Elliott, Richard

S corporations offer significant tax savings by eliminating a second level of tax on corporate earnings. Although generally used for U.S. operations, there are numerous opportunities for their use in foreign operations. Key issues facing S corporations with foreign operations are (1) avoiding inadvertent termination of S status by owning 80% or more of a foreign subsidiary, and (2) obtaining a foreign tax credit (FTC) for foreign taxes by structuring foreign operations to allow a flowthrough of foreign taxes. With planning, S corporation benefits can effectively be made available to foreign investors.

Corporations frequently begin doing business abroad by exporting U.S. goods or services and do not require a foreign presence. As foreign operations expand, however, a corporation may wish to establish a foreign branch or subsidiary. The choice between a branch and a subsidiary will be influenced by foreign law, business considerations, and U.S. and foreign tax considerations.

Export activities not involving a foreign presence usually do not have foreign tax consequences. U.S. taxation of these activities will not differ significantly from U.S. taxation of domestic activities. If possible, S corporations should ensure that title to exported goods passes outside the United States so the export sales income may be considered foreign source. If a foreign presence is later established, the additional foreign-source export income, to the extent it is not heavily taxed by a foreign government, will often increase the U.S. FTC and offset U. S. tax on other foreign income.

Use of a foreign sales corporation (FSC) or an interest-charge domestic international sales corporation (IC-DISC) generally is not beneficial to S corporations. Use of an FSC will result in double taxation because the S shareholders are not eligible for the special FSC dividends received deduction under Sec. 245(c). An IC-DISC, which permits deferral of tax on a part of export income but imposes an interest charge on the deferral, generally is not beneficial because the interest is not deductible to the S shareholders.

An S corporation that requires a presence in a foreign country may conduct its business through a branch in that country, rather than through a separate legal entity, by registering to do business in the foreign country. Most foreign countries will recognize S corporations as separate legal entities for both business purposes (such as limited liability) and tax...