Going Global, Part II

Small companies are joining larger counterparts in the international arena. The second of a two-part series looks at key issues and challenges

Although exporting is often believed to be reserved for large companies, many fast-on-their feet entrepreneurs are looking to sell overseas to offset a decline in sales domestically. But how do they do it, and what do they need to know? Glenn Aquino and Bill Callahan, tax partners in PricewaterhouseCoopers’ Private Company Services group, answered those questions for Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow. (This is the second of a two-part examination of this topic of conducting business globally. For the first article, see BusinessWeek.com, 8/14/06, "Going Global, Part I.")

What kinds of issues are your clients bringing to you in regards to the tax and financial implications of doing business overseas?

Aquino: We're seeing increasing product sourcing from overseas, and that's often the initial foray a small company makes into globalization. They start by asking us how to develop relationships outside the U.S. so they can import or export products.

Callahan: I talk to companies that want to expand outside of the U.S., so that conversation covers all the bases: sales, marketing, distribution channels, manufacturing, and business services. Other companies are now using personnel outside of the U.S. to provide a service that might cost more if they hired domestically.

What are some of the things you advise entrepreneurs to look into initially?

Aquino: For companies expanding into foreign countries, they need to decide what kind of presence they want to have. A first start might be a representative office arrangement, where you're going to send somebody in your company overseas but you're not going to do enough business there to subject the company to paying taxes in that jurisdiction.

Callahan: What can and can't be done, in terms of establishing a taxable presence overseas, differs from country to country. But in terms of benefits, if you have a simple office, with maybe a sales rep or two, and that doesn't make for a taxable presence in that jurisdiction, your company will be incurring a lot of expenses that can be deducted here at home.

What about companies that want to do more and actually set up a branch office in another country?

Aquino: Again, depending on the legal structure of the branch and the laws of that country, something like that typically would have a taxable presence that would have to be registered with the local authorities.

What's the next level up?

Callahan: Actually forming a corporation in that jurisdiction. Typically, that entity has more substance, it has capital requirements, and there are local regulatory and filing issues that you have to follow. From a U.S. tax perspective, it's possible to treat a foreign corporation as if it were a branch of your company for tax purposes.

Hiring someone overseas to work for your company seems like a tricky proposition. How advisable is it?

Callahan: It really depends on the business and the industry. A number of our clients go into a country and immediately they try to establish a relationship with someone in the country so that person can work for them. Others take someone from their U.S.-based operation and turn him or her into an [expatriate] for two or three years, with the mission of organizing a foreign entity and starting the company.

Aquino: By the way, sending one of your employees overseas is very costly. Plan to pay at least double for that employee. So if you'd normally pay that person $100,000 here, it will cost you $200,000 over there, if you include a housing allowance, visits back home, and things like that.

We tell clients that if they plan to send several people into a foreign office eventually, they should think about establishing some policy guidelines up front. For instance, will they all get housing and car allowances? What about paying for American schools for their children? Will you expect them to pay personal taxes in that country and here—or will you pay their taxes in one of the jurisdictions?

How do you guide small-business owners who are wondering whether they should take the leap or not?

Callahan: We tell them to make multiple visits, meet with potential customers and with the trade ministry in that country and [learn about] the U.S. economic presence there. Being there helps you get the lay of the land, and it can also help you identify a local contact that you'd like to have working for you or with you.

Aquino: There are so many ready sources of information available these days. Entrepreneurs can do a good deal of due diligence on their own, though at the end of the day they will probably need somebody who has experience expanding overseas and who can share their insights.

How popular is the idea of partnering with an overseas company as a way to carry out a global expansion?

Callahan: It is popular, because it allows you to use someone else's marketplace distribution channel or manufacturing process. You wind up making a smaller commitment than if you're doing it all by yourself. However, finding a joint venture partner brings its own set of issues. How much do you disclose about your business? Can you risk potentially losing proprietary knowledge? How will you set up your partnership?

What about the political, cultural, and economic issues of expansion?

Callahan: You do need to be aware of all those factors, but the good news is that other than in the Middle East right now, most of the countries that used to have onerous restrictions on business have greatly lessened or eliminated them. Several years ago, for instance, you could make loads of money in China but you couldn't get your cash out without obtaining central bank approval, which was difficult and risky.

Since China has joined the global economy over the past few years, however, the laws have changed, and foreigners can move money in and out of the country fairly freely now (see BusinessWeek.com, 1/4/06, "Before You Set Up Shop in China…"). Even the language barriers have eased a lot as people increasingly speak English all over the world.

Aquino: That brings up another planning point. Anytime you expand your business into another country, you want to plan for how you're going to go in, how you will operate and make money there, and how you'll get out. Some countries, for instance, have stringent rules about the termination of employees, and you may find that the cost to terminate employees at your overseas company is prohibitive. You want to think about the entire life cycle of your global expansion; in other words, not just about the first six months or a year.