Only Chad and the United Arab Emirates have corporate taxes that are higher than those of the US. Therefore, if your profits end up being taxed outside of the US, you are likely to save money. Profit shifting (moving your money from your high-tax US pocket to your low/no-tax foreign pocket) to minimize US taxes is a strategy utilized by Apple, Google and a number of other major software companies. Smaller IT businesses can take advantage of a simplified version of multinational giants’ strategy as follows.
Basics
The basic idea is that you need for form a US subsidiary of your foreign/offshore parent company. Foreign parent sells ownership rights to the software to the US subsidiary who then distributes the software to US end user and collects license fees from them. Normally, profits generated by the US subsidiary from US end users would be “US source income” that is subject to US tax. However, your foreign parent company bills its US subsidiary for maintenance and support of the software that the parent company had sold to its US subsidiary. Such services must be provided from outside of the US. If the value of foreign maintenance services is roughly equal to the amount of US user fees, then US sub will end up no profit to be taxed on, all profit will shift to its foreign parent.
Isn't income from US sub a ‘US source income’?
At this point you might be wondering, “But if the foreign company has received service fees from its own US sub for servicing of US-owned software, wouldn’t that be ‘US source income’ taxable in the US?” No, not if the services were all provided from outside the US. US tax law states that determination of the source of income of services depends on the jurisdiction where these services were actually provided. If the services were provided from within the US, it’s “US source income” taxable in the US. Otherwise, it’s foreign-source income taxable in accordance to the laws of that foreign jurisdiction. Your foreign jurisdiction is likely to have lower taxes than the US.
Should we license or sell the software to our US sub?
You have to sell it. Here is the law in the US. When a foreign company licenses software to a US company, the income generated is considered to be a “royalty.” Royalty income for SaaS used in the US is “US source income” taxable in the US. So, your Singapore company would have to pay 30% withholding tax on monies received from licensing soft to a US entity. That’s not good but there is another way.
On the other hand, when a foreign company sells ownership rights in the software to a US company, the income generated is not “US source income.” The foreign company will not be taxed on that income in the US. It will only have to pay whatever foreign tax it is subject to.
So, to avoid being subject to US tax, you would have to sell ownership rights in the software to a US subsidiary.
We are not an IT business, can we still utilize a profit shifting strategy?
Yes, if you can find a way to legitimately bill your US subsidiary for services that are provided from outside of the US. US earnings can also be effectively repatriated tax free by a low interest loan to the foreign parent holding company.
