Nobody likes the Hiccups, especially in the course of (or subsequent) to a multi-million dollar acquisition of a US business.

What are some of the more common Cross-Border tax and legal issues to consider when acquiring a US business?

Income Tax Drainage

Many companies (and even some professionals) may sometimes overlook the basic question as to which entity is the most appropriate to purchase the US business, e.g., should it be CanCo, or CanCo’s US subsidiary, USCo?

There are arguments for both sides, e.g., creditor proofing versus income tax implications.  By way of example, if Canadian business is acquiring a US software business (whose main asset is Intellectual Property [“IP”]), which entity should purchase or be the legal owner of the US Business (CanCo or USCo)?

Well, it depends on your client’s goals and objectives.  One may strongly argue that CanCo should purchase the IP, and lease the IP to USCo.  This will allow for at least some US tax coverage (depending on the value of the IP and Transfer Pricing considerations) by way of Royalty from USCo to CanCo. 

Traps for the Unwary: We must be cognizant of the fact that inappropriate remuneration from USCo to CanCo may actually create a tax situation wherein USCo has essentially purchased the IP from CanCo.  This would trap the IP’s built-in-gain in the US tax net.  Practitioners should also look for the opportunity to perform some off-shore tax planning with a “cost sharing” arrangement.

Unintended Permanent Establishment and State Nexus

In the discussion above, it looks as if we have solved our client’s issues, or have we only started them?

What happens when CanCo purchases the US business, does it now cause a Permanent Establishment, or State Nexus thus subjecting CanCo to US Federal and/or State income tax?

The answer, again, is that it depends on many different factors.  One primary factor is the inter-company relationship struck between CanCo and USCo.  Is this relationship documented by inter-company agreements that will withstand US Federal and State income tax scrutiny?

What about the US tax filings? If an asset purchase is negotiated, then an allocation of purchase price will need to be filed with the US government on a Form 8594.  Does CanCo file this form? If so, then does CanCo’s filing of a Form 8594 affirmatively assert a position that CanCo has a US Trade or Business? Does this lead to a mandatory filing of a Form 1120-F (US Branch Return)?

Conclusion

Hopefully, a US acquisition will lead to increased profits and the further penetration of the US marketplace.  However, most business owners may agree to one proposition: business owners need certainty and wish to avoid un-intended negative consequences. Thus, upon commencement of a US acquisition, business owners are well-advised to seek professional counsel.