Leverage Your Playing Field
A business’ playing field can be as small as a town or as large as the globe. The playing field is the area in which a business serves clients, faces competition, and in which it is feasible to obtain required business inputs.
Prior to WWII, most small businesses had a modest playing field, more or less equal to their target market. Today, a modern business’ playing field is usually exponentially larger than the area within which it serves customers. This expansion was first driven by global trade growth after WW II. Over the last several decades, the average playing field has been further extended as a result of the digital transformation of global economies and revolutionary advancements in global communications and logistics.
Having a large playing field can be a curse and a blessing. It’s a curse because it often results in a situation where a small competitor in a remote corner of the world can effectively compete with your business. It’s a blessing because it provides the business with the flexibility to procure needed resources from anywhere on the globe.
This resource flexibility that comes with a large playing field allows a business to strategically plan and execute its international business strategy in a way that will permit it to compete more effectively. As discussed below, resource flexibility also allows a business to strategically modify its existing supply chains to accommodate the rise of geopolitical tensions in various locations. The bottom line is that a strong understanding of your playing field will give you insights into how to operate effectively and competitively.
Determine the Level of Product or Service Customization and Plan the International Structure Expansion Accordingly
The level of standardization or customization of a product or service will often be a key consideration in determining the appropriate legal entity structure and operating strategy for a business that is expanding internationally. Depending on the product or service, both models can be very successful. For example, consider global brands like Coca-Cola and McDonalds. One has found success by offering a standard soft drink globally, while the other has chosen some degree of customization of its menu for each country.
If a business’s product or service offering requires little or no customization from country to country, management and marketing functions related to foreign sales can be effectively carried out in the home company. The foreign entity can focus on marketing and sales, and the home company can provide management and back-office services in exchange for an intercompany service fee. In other cases, a business with a globally standardized product or service should be able to leverage an export model that will not require setting up a foreign entity.
On the other hand, when a business’s product or service requires extensive and ongoing customization to suit varying customer tastes from country to country, it will be often be best to set up a foreign entity in each market. The foreign entity oversees and manages the local customization process to ensure that any changes in customer tastes or preferences are quickly identified and taken into account.
Entity Selection
Choosing the correct entity type for foreign operations is crucial for achieving overall tax efficiency. The right choice depends on an analysis of the following questions:
(i) What will be the relative business functions of the home country entity vs. the foreign entity, and what kind of intercompany transactions need to be carried out? There is not one correct answer to this question, and there are multiple ways to structure business functions and intercompany transactions to achieve maximum tax efficiency.
(ii) Does the business plan involve reinvesting earnings back into the business, or is the plan to immediately repatriate foreign earnings to ultimate owners? Typically, setting up a company is the suitable choice for the goal of reinvesting earnings into the continued growth of the business.
(iii) Is the home country entity a company, partnership, LLC, or some other type of entity? This is relevant for several reasons, including foreign tax credit purposes. The ability to credit foreign taxes is not always possible. It depends on choosing the right type of foreign entity that will permit the home country entity to take a foreign tax credit for income taxes paid by the foreign entity.
The above issues should be carefully analyzed and resolved before setting up the foreign entity. Otherwise, there is a substantial risk that the foreign and U.S. entities will not be properly integrated to achieve business objectives and tax efficiency.
Ownership and Exploitation of Intellectual Property (“I.P.”)
For many businesses, the most valuable assets on their balance sheet are intellectual property rights. The common types of I.P. owned by businesses are trademarks, patents, and copyrights. Suppose a company has I.P. that will be significantly used and exploited as part of its international operations. In that case, developing a strategic plan for tax-efficient ownership and exploitation of such I.P. will be highly advantageous.
In some cases, owning and exploiting the I.P. from the home country will be reasonably tax efficient. In other cases, moving the I.P. to a foreign entity with a wide network of tax treaties will minimize income and withholding taxes related to I.P. income.
If the business’s strategic plan calls for moving the I.P. to a different country, this transfer should occur as early as possible to avoid the tax cost of transferring the I.P. after it has gained substantial value. The more valuable the I.P., the higher the potential exit tax of transferring it to a strategic foreign jurisdiction.
Plan Ahead to Avoid Potential Supply Chain Disruptions
When developing supply chain options involving foreign procurement or manufacturing, businesses should consider the risk that current or potential geopolitical tensions will cause disruptions to their supply chain. During the pandemic, countless companies and customers across the globe were victims of crippling disruptions in getting goods out of key production centers in Asia. The rise in geopolitical disruptions in the years immediately following the pandemic is a further reason for businesses to diversify their procurement or production locations to mitigate the potentially crippling impact of external events.
For many U.S. companies, this means diversifying the suppliers of raw materials and manufacturing to be closer to U.S. customers wherever possible, using a strategy called “Near Shoring.” Near Shoring has contributed to Mexico surpassing China as the U.S.’ biggest trading partner.
Connect with our International Team
In today's interconnected global economy, understanding and strategically navigating a business's expanded playing field is essential for sustained success. The ability to leverage resources and opportunities across borders provides flexibility and competitive advantage, yet it also exposes businesses to diverse challenges, from global competition to geopolitical risks. Strategic decisions such as entity selection for foreign operations and intellectual property management can significantly impact a company's tax efficiency and operational agility. Furthermore, proactive planning, including supply chain diversification through strategies like Near Shoring, is crucial to mitigating potential disruptions and maintaining resilience in an increasingly complex global landscape. By carefully analyzing and adapting to these dynamics, businesses can position themselves not only to thrive but also to lead in their respective markets worldwide.
Connect with M&S International