New Zealand companies taking their businesses into the United States need to carefully consider the type of US company they incorporate and how best to ensure that most of the US profits are not lost in taxes. It is critical that the transfer pricing policies are robust so that no more than a fair amount of the profit is allocated to the US entity.

What form of entity to set-up in the US?

In practice a US company is preferred so as to contract with US customers for the sale of goods or services. But should that company be a limited liability company (LLC) or a c-corporation? Both provide their members with limited liability protection. An LLC can be easier to set up and more flexible, but this is not a significant advantage.

The main difference lies in the US tax treatment of each type of entity. An LLC is effectively treated as a partnership (or sole proprietor for a single owner) for US tax purposes, which is a disregarded entity. Each LLC member is directly taxable in the US on their share of profits effectively connected with the US, at their own marginal tax rates. There is no second layer of tax on a dividend. The LLC can, however, elect to be taxed as a separate entity (as a c-corp).

If a NZ company owns the LLC, the NZ parent has to register for US tax and is taxed at the federal corporate tax rate on the US profits (currently 21%) plus state taxes, if applicable (typically a combined rate of 26% is used to estimate overall corporate tax in US).

A c-corp is established in a particular state and issues stock to shareholders. It is taxed at the corporate federal tax rate (currently 21%) plus state taxes, where applicable.

For both LLC and c-corp entities, double tax will typically occur when US profits are distributed through a NZ parent to the ultimate NZ owners. The overall effective tax rate can be 50%–55%. The table below summarises the differences between an LLC and c-corp assuming a NZ company owns the US entity.

Another type of US entity is an s-corp, which is not strictly a different legal entity, but rather a designation for US tax purposes (like a ‘look-through company’ designation in NZ). An LLC or c-corp can elect to be an s-corp provided they meet certain requirements, including having less than 100 shareholders and with no non-corporate or non-resident alien shareholders. Electing to be an s-corp means that business income of the entity passes through to be taxed to the owners (like an LLC).

Should individuals/trusts directly own the US entity?

What if the individual NZ investors are the direct LLC members or own shares in the c-corp (i.e., the US company is a sister company to their NZ company)?

Double tax still arises in both cases. US federal and state tax is paid by the c-corp (or by the NZ investor in an LLC). US withholding tax is paid on a dividend from a c-corp and NZ tax is paid on dividends received by the NZ shareholder. The overall effective tax rate could still be as high as 55% irrespective of whether an investor chooses a c-corp or an LLC entity.

The comparative advantage in using a c-corp is that a NZ investor is only taxed in NZ if a dividend is actually paid. But with an LLC, a dividend is automatically treated as paid when profits are formally distributed to its NZ members.

Be careful if a member of an LLC is a NZ trust as it would usually be taxed at 37% as a ‘non-grantor trust’. The overall effective tax rate could be as high as 62%.

If an LLC is a look-through company in NZ, does that overcome double tax?

It is possible to use the ‘look-through company’ (LTC) regime to overcome double tax. NZ individual investors would be the members of the LLC and the LLC could elect to be a LTC for NZ tax purposes. There are many requirements to qualify for LTC status, including having no more than five look-through counted owners and it must be NZ tax resident and not non-resident under a tax treaty. LTC status is possible for an LLC where director control (if any) is exercised from NZ or the centre of management of the LLC is in NZ.

If it elects to be an LTC, the NZ investors are taxed in both US and NZ on their share of the LLC profits. But a NZ investor should be able to claim a foreign tax credit for US federal tax paid against their NZ tax. Double tax would be averted. However, the investor will have an effective tax rate at the higher of US and NZ marginal taxes on their US profits (possibly up to 39%).

A caution on this structure is that it can be rather compliance heavy. The structure must be an LLC rather than a C-corp. Also note that for LTC status to be maintained, the LTC requirements must continually be met.

Robust transfer pricing policies

With all structures, transfer pricing must be considered for all cross-border transactions between related parties. Even if an LLC elects to be an LTC, transfer pricing is relevant to determine the amount of US tax payable which is claimed as a foreign tax claim against NZ taxes.

Mitigation of double tax costs, using a ‘vanilla’ structure (such as NZ parent owning the shares in a US c-corporation), can usually be achieved by ensuring there are robust transfer pricing policies.

Invariably, the NZ parent supplies the US entity with products, intellectual property, loans and/or management services to its related US company. The transfer pricing policies can have a substantial impact on the incidence of double tax.

If the US company has few employees in the US to create demand and make sales, it would initially be expected to earn only modest profit margins (or perhaps losses). If the NZ parent creates most value for the US business and controls decision-making on risks, it would be expected to earn most of the group profits from sales to US customers.

The incidence of double tax can be substantially mitigated if only a small proportion of group profit is required to be reported in the US. Other structuring to minimise double tax may be possible but may also present greater complexity and compliance.