When Is The Right Time To Dive Into The Hot U.S. Economy?

An article on the impact of the Biden Administration.

Doing business in the U.S.

Many European companies realized a healthy year-over-year increase in their U.S. revenues for fiscal year  2020. This was especially the case for E-commerce companies that saw  sharp increases, often as a direct result of Covid-19. European companies have benefited from the strong recovery in the U.S. in the later part of 2020 which appears to be carrying over into 2021; the U.S. economy grew by 6.5% in Q1 2021 and the GDP growth is forecast for 2021 to exceed 6%.

Setting-up a U.S. Subsidiary

For many companies this leads to the question, ”Should we keep targeting the U.S. market remotely or set up a U.S. subsidiary?”. When is it still OK to tip your toes in the water to assess the U.S. market, and when is the right time to ‘dive in’ and set up a U.S. subsidiary so you can maximize the benefits of the biggest global economy’s growth?

TABS Market Research

While the view has shifted in the last decade, European entrepreneurs are still reluctant regarding the real and perceived risks associated with doing business in the U.S. When TABS conducted its first survey amongst European companies doing business in the U.S. in 2013, the majority of participants were still mostly concerned about product liability and the impact that this may have on the assets in the European headquarters. For many European companies this was a reason to target the U.S. remotely and ‘safely’ from Europe. Since 2013, our survey results indicate that more and more companies are entering the U.S. economy with a local subsidiary and receiving the benefits therefrom. In our 2020 survey we saw  a significant increase in the percentage of companies who opted for a local U.S. presence in a much earlier stage. 

What caused this shift, and what was the impact on the performance of companies that went ‘all in’? We believe that there are a number of reasons why this shift has occurred – we have addressed some of them below – and we believe that this trend will continue during the Biden administration.

Download our market research report!

Benefits of local U.S. presence

• Better risk management
• Lower Corporate Income Taxes
• Facilitates with work visas
• Limiting Sales Tax exposure to U.S. subsidiary 
• Local presence increases business opportunities 

Risk Management

This first reason for the shift from 2013 to now is a better understanding of the real vs. perceived risks within the legal landscape. Entrepreneurs have come to realize that the newspaper stories that reached Europe about product liability were often grossly exaggerated. With proper preparation, including sound legal advice, establishing safety procedures, and implementing a solid insurance strategy, companies can mitigate and manage these risks that have scared them away in the past. In fact, many companies found that the establishment of a U.S. entity actually can further isolate the risks to that entity and protect their European operations and shareholders.

Corporate Income Taxes

The second reason for the shift is the more recent change in corporate income taxes in the U.S. Historically advice from tax specialists was to limit activities in the U.S., and thus the U.S. based added value, to justify minimal taxable income in the U.S. With a corporate federal income tax rate of 35% before the Trump administration’s Tax Cuts and Jobs Act (TCJA) of 2017, this was often a dominant factor; it made far more sense to take profits in the lower European tax jurisdictions. However, the TCJA lowered the federal rate to a much more competitive 21% and with that, it became more advantageous to have a bigger team in the U.S. and leave more added value (and thus profit margins) in the U.S.

Work visas

The third reason for the shift is the changes in immigration policies that began under the Trump administration. The overall perception during the Trump administration’s ‘America First’ policy was that the requirements were getting harder for obtaining  work permits for foreign workers and that more individuals were being ‘caught’ violating work policies related to their tourist visas. Although European companies were still able to obtain visas, many did not want to take any chance and elected to create more substance in a U.S. entity to increase the chance of visa approvals.

Sales taxes

The fourth, and most state specific reason for entrepreneurs to elect to create a U.S. entity in the earlier stages of their U.S. expansion, was the result of a Supreme Court decision in June of 2018 related to sales tax. The Supreme Court’s decision in South Dakota vs. Wayfair gave states taxing authority over remote sellers based upon a simple economic nexus. Prior to that, a company had to have a physical tie to a state in order for that state to be able to require the collection and remittance of sales tax. This meant that even foreign entities selling into a state could create enough economic activity for states to argue that they have ‘economic nexus’ in their state and are thereby subject to the sales tax laws for the  collection and remittance of sales tax on transactions in that state. The U.S. based sales tax system is very complicated and has many pitfalls. European companies are seeing the advantages to having a U.S. entity that creates a separation between the European assets, books and records in connection with potential audits. For most states, Sales & Use Tax has become an increasingly important source of their revenues and with assistance of sophisticated information systems, states are beginning to go after foreign companies who are competing with their local entrepreneurs without charging sales tax. Rather than exposing their foreign entity to the difficult Sales & Use Tax administration, foreign entrepreneurs prefer to isolate the risk by setting up a U.S. subsidiary and letting that local entity deal with these matters.

Local presence

Based largely on the above, a larger percentage of foreign companies operating in the U.S. market decided to do so via a U.S. subsidiary in recent years.They often did this reluctantly at first, but based upon responses provided in the 2020 survey a vast majority were very happily surprised with the benefits they realized by establishing a local presence especially if they hired a local team. The survey and qualitative interviews showed that companies with a local team in the U.S. performed significantly better than those without a U.S. subsidiary, or their colleagues who were managing their U.S. subsidiary predominantly from Europe. 

It turns out that most Americans, both in B2C and B2B arena, prefer to do business with a U.S. entity over a foreign entity. Many of the surveyed European companies realized in recent years that they had underestimated this impact and had previously missed out on an opportunity to maximize their U.S. market potential. This is not only a matter of ‘buy American’ or Americans rather dealing with the ‘known’ than the ‘unknown’. It is based upon rules and regulations that require additional administrative burdens for them when dealing with foreign entities. For example, U.S. companies who pay foreign vendors have to request W8BEN-E forms from those vendors, decide on whether to withhold taxes on foreign bills and act as a withholding agent. And at the end of the year, they have to report payments made to foreign vendors to the IRS via an additional filing (Form 1042). If these U.S. companies have the opportunity to do this same transaction with a U.S. entity instead, it  eliminates these administrative burdens, and they will definitely choose to deal with a local entity.

Full steam ahead

The U.S. economy is moving full steam ahead in 2021. This is partly as a result of the unprecedented economic relief packages that have already been passed, and the apparent appetite to provide more which are currently being negotiated in the U.S. Senate. In order to pay for the enormous Covid economic relief packages, the Biden administration has proposed to partially reverse the TCJA tax rate reduction. Some argue that Biden’s proposed hike of the federal corporate tax rate back to 28% will cause many international companies to retreat, or at least reduce their substance in the U.S. again.  Although this Biden proposal would indeed bring the average total tax rate, including state and local taxes, back to a relatively high 32% rate compared to other global economies, it is doubtful that companies will reduce their U.S. substance. Nor do we believe that it will stop European companies from setting up a U.S. subsidiary in the future.

Via transfer pricing studies, the taxable income that foreign companies allocate to the U.S. is still so low, that the benefits of the U.S. market with its current growth, far outweigh the higher potential tax burden for foreign owned companies. Many European companies want to maximize how they can benefit from the trillions of U.S. dollars that will be invested in the U.S. economy in the near future via these economic relief packages.

Last but not least, Biden has indicated that he intends to increase the IRS workforce by 15% each year for the next 10 years for enforcement purposes. In recent years, the IRS budget and workforce had fallen so low, that many foreign companies were (often unknowingly) operating with nexus in the U.S. for years without paying taxes and without getting on the IRS radar. Together with the increase of international cooperation and information exchange between tax authorities, the Biden administration aims to significantly reduce the ‘tax gap’ between what taxpayers owe and what they pay to the IRS, by $1.4 trillion in those 10 years. Granted, this will be mostly on reducing tax evasion on the Personal Income Tax side, however, for many foreign companies this will be another reason to choose to operate in the U.S. with a U.S. subsidiary, and to keep their European headquarters safe from Uncle Sam. 

Stay informed

Subscribe to our 2-monthly business update ‘TABS Talk’ or follow us on LinkedIn.