Structuring US Inbound Investment: Navigating the US Tax Landscape

As the US is the largest economy in the world, it continues to attract foreign investment with its dynamic workforce, robust infrastructure and access to capital investment. The complexity of the US tax system, encompassing taxes at the federal, state and local levels, can be daunting for inbound investors. Missteps in navigating these systems can result in unanticipated tax liabilities, missed opportunities and operating inefficiencies.

This article is intended to provide a broad overview of certain tax issues and opportunities faced by inbound investment. We are available to help guide businesses to navigate the increasingly complex US tax landscape. A bespoke consultation should be undertaken prior to making any business and/or tax-related decisions to fully understand the impact of those decisions on any particular investment.

Basics of US federal income tax

Who is the taxpayer?

The US tax system distinguishes between resident and non-residents. Residents (including US citizens and corporations) are taxed on their worldwide income whereas non-residents are generally only taxed on income effectively connected to a US trade or business (referred to as “ECI”) and US sourced fixed, determinable, annual or periodic (FDAP) income (e.g., interest, dividends, rents, royalties).

The US tax code does not define a US trade or business, though US case law generally frames it to include a profit-motivated activity that is “considerable, continuous, regular and substantial.” If the non-US business is located in a country that has an existing US double tax treaty (e.g., the UK), this US trade or business standard is raised to the generally higher permanent establishment (PE) threshold. Broadly, a PE tends to include either a fixed place of business in the US or dependent agents performing certain revenue-generating activities within the US.

What’s the rate of tax?

Non-US companies that generate ECI connected to a US trade or business are taxed similarly to domestic businesses, with a current 21% rate of federal tax. In additional to federal taxes, state and local income taxes may also apply. Although the rates vary by state, typically businesses have a blended marginal federal and state rate of 25%.

US source FDAP income is taxed on a gross basis at 30% and is levied by way of withholding at source. Such rate can be reduced, however, if the FDAP recipient is eligible for treaty benefits and/or a statutory exemption applies. For UK resident recipients, interest and royalties withholding can be reduced to 0% under the treaty and dividend withholding can be reduced to 0/5/15%. Any reductions are dependent upon satisfying the criteria in the relevant treaty article/statute.

Choice of entity

There are a variety of ways in which to structure a US business, including a representative office, branch office or US corporate subsidiary. The choice can be driven by commercial requirements (e.g., the need to establish a US bank account, customer requirements, etc.), but tax often plays a part in choosing the most suitable structure. Although each alternative will have local country, legal and/or regulatory implications, this article focuses on the US tax considerations of each alternative.

1. Representative office: A representative office is typically the easiest way to initially structure a US business. If the US activities are very limited, it may not even trigger a federal tax liability. This may be the most appropriate choice when a business is making its first foray into the US market as the upfront costs can be minimal and the maintenance costs are usually manageable. Representative offices would typically need to be transitioned into a more formal structure as the business grows.
2. Branch office: A branch office can be organised as a legal entity (e.g., a US limited liability company, LLC), though a legal entity isn’t required. A branch would typically trigger a US taxable presence for the home office and as a result, items of US income, gain, deductions and losses must be properly accounted for and reported to the federal and state tax authorities. The non-US branch owner will be the US tax filer obligated to file and pay and relevant federal and state taxes. Note that US LLCs treated as branches for US tax purposes can create additional complexity for the branch owner, in particular for UK companies, and as such, should be carefully considered prior to implementation.
3. US corporate subsidiary: Non-US businesses that intend to have people or property in the US on a more permanent basis typically choose to incorporate a US corporate subsidiary (referred to as an Inc or C-corporation) as a means to “ring fence” the US tax filing and payment obligations to the US entity. A US corporation does not need to be organised in the state in which it is doing business and many businesses choose to incorporate in the state of Delaware as it is generally viewed as a “business-friendly” state. As with the branch office structures, advice should be taken prior to implementation.

State, local and other taxes

In addition to federal income taxes, companies doing business in the US may be subject to a myriad of other taxes at the national and sub-national level. These can include state and local income taxes, sales tax, real and personal property taxes, employment taxes, among others.

This article provides a brief overview of some of these taxes.

State income taxes

Most inbound businesses are surprised to learn that they may be subject to state income taxes not only in their state of incorporation, but also in any state where the company has “nexus.” Nexus (or taxable presence) can be created when a company has people or property in a state, including but not limited to employees/agents working from a home office, inventory warehoused at a third-party warehouse and employees temporarily in a state for business. Increasingly, a lot of states are creating economic nexus statutes under which nexus can be created if the business is generating a significant amount of income from customers within the state (even if the business has no people or property in that state). As a result, it’s not uncommon for companies to have nexus, meaning a tax filing and/or payment obligation, in multiple states.

Just because a business has nexus in multiple states does not mean all of the income of that business is fully subject to tax in every state; rather the income is allocated and apportioned amongst those states. Most states use federal taxable income as a starting point and then make certain adjustments to calculate state tax liability. As a result, state taxable income can vary across different states.

State sales and use taxes

Unlike the UK and many other countries, the US does not impose value-added tax (VAT) and there is no federal-level consumption-based tax. Instead, consumption-based taxes are levied at the state (and in some cases, local) level and are typically referred to as “sales and use taxes.” Sales (or similar) taxes are currently levied in 45 states and unlike VAT, are not levied (and potentially claimed back) on each leg of a supply chain; rather sales tax is usually only levied on the “end user” of the product or service.

In states that have sales tax, most will levy tax on the sale of tangible personal property (unless explicitly exempted under state law). A handful of states also tax intangible property and/or services.

Prior to 2018, a seller generally needed to have a physical presence in a state in order to trigger an obligation to collect and remit sales tax on in-state sales. Following the Supreme Court ruling in South Dakota vs. Wayfair Inc. (referred to as Wayfair), states have been permitted to enact statues that impose a sales tax collection and remittance obligation on remote/distance sellers. Most states with remote seller rules have dollar amount and/or transaction thresholds before the sales tax requirement kicks in, though these thresholds vary by state.

Inbound companies (including remote sellers) selling into the US market should analyse their state sales tax obligations, including whether the product/service is taxable in a state, whether the seller has systems in place to track the location of end users and whether any sales tax filing/registration/payment obligations have been breached. Inbound companies that do not comply with their sales tax obligations can face significant penalties and may ultimately be on the hook for the underlying tax.

Employment taxes

Employers will also need to factor in both federal and state payroll taxes. Human capital can become quite complex for inbound companies.

1. Social Security Tax (FICA): FICA is split equally between the employer and employee at 12.4% of wages up to a wage cap ($176,100 for 2025 earnings).
2. Medicare Tax: An additional 2.9% Medicare Tax is split equally between the employer and employee with no wage cap. An Additional Medicare Tax is due when wages exceed $200,000.
3. Federal Unemployment Tax (FUTA): FUTA is levied at 6% on the first $7,000 of wages per employee. Note most states operate their own unemployment taxes; rates vary by state.

Because of the complexity involved in managing payroll, inbound companies typically choose to outsource the payroll function to third party service providers.

Financing US operations

If a US subsidiary is organised, the home office will need to assess how to fund the US operations. Funding is typically via debt, equity (i.e., capital contributions) or a mix of the two. As a result of various Internal Revenue Service (IRS) restrictions on interest deductibility and debt v. equity principles, it is generally recommended that US operations are not fully debt funded.

Interest payments by a US company to a non-US lender are generally subject to a 30% rate of US tax levied by way of withholding. This rate can be reduced under an applicable US double tax treaty (as well as certain statutory exemptions). For example, the US/UK double tax treaty reduces the rate to 0% so long as the interest recipient is treaty qualified. Eligibility for a reduced rate should be confirmed prior to paying any interest, including relevant Form W-8 reporting (e.g., Form W-8BEN-E, Certificate for Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)).

Cash repatriation

Once the US business is up and running, companies will need to think about how to efficiently repatriate any excess cash to the home office. Assuming a US corporate subsidiary is organised, distributions from US corporations to non-US shareholders are subject to a 30% rate of US tax levied by way of withholding (i.e., FDAP withholding). The 30% rate can be reduced under an applicable US double tax treaty if the shareholder is treaty qualified. In the case of a UK treaty qualified company with a wholly owned US subsidiary, the rate could be reduced to either 0% or 5%, subject to certain additional requirements being met. Eligibility for a reduced rate should be confirmed prior to paying any interest, including relevant Form W-8 reporting (e.g., Form W-8BEN-E, Certificate for Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)).

When withholding taxes apply, in particular when those taxes are not creditable in the home country, many companies choose to use repayment of debt as a means to repatriate cash free from withholding. For example, if the US operations were funded by a loan from the UK parent company, US excess cash could be used to pay down principle as a means of repatriating cash to the home office without suffering withholding.

What are the risks?

Companies thinking about expanding into the US market should ensure their US operating model is structured appropriately to avoid potentially costly mistakes. Failure to comply with both the federal and state filing and compliance obligations can attract significant penalties and interest and could cause the company to be liable for the underlying taxes of others (e.g., customer sales taxes). Companies risk tax audit adjustments at the federal, state and local levels. In addition, companies that are working towards external investment and/or exit need to be mindful of tax issues that can arise during the diligence process and could result in a chip on the purchase price, or even failure of the overall deal.

We are available to help guide companies to establish their initial US operating models, review existing models to ensure they are fit for purpose and help with all corporate tax filings and compliance.

The information in this publication provides a broad overview of the topics addressed. While we strive for accuracy, we cannot guarantee it will remain accurate in the future. It should not be considered exhaustive or relied upon for decision-making or as a substitute for professional advice. Ostberg Sinclair is not responsible for any consequences arising from actions taken or not taken based on this material. Please contact us if you would like to discuss your specific circumstances further.