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Structuring the Investment — Entity Choice & Tax-Efficiency

The United States is one of the most attractive places for foreign capital — deep markets, relative stability, and strong investor Once an inbound investor decides to enter the U.S. market, the next decision — how to structure the investment — can drive the ultimate tax result significantly. The U.S. system taxes differently depending on the type of entity, its ownership, and whether treaty benefits apply.. But the U.S. also has a uniquely complex tax environment.

This article summarizes considerations for entity selection, including notation of federal, treaty, and state regimes, and practical planning points.

1. Balancing Tax Efficiency, Liability Protection & Compliance

Every inbound structure should balance three objectives:

1. Liability protection — containing business legal risk within the U.S. entity.
2. Tax efficiency — minimizing both U.S. and home-country tax leakage.
3. Administrative manageability — minimizing annual administrative tasks and costs.

While the right structure depends on the investor’s facts — activity and income type, treaty position, and cash planning — there are key guardrails to consider.

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2. Basic Options: Direct or U.S. Blocker, Foreign Holding Company Considerations

A. Direct Investment by the Non-Resident

This is the simplest on paper — the investor (either a foreign individual or foreign holding company) directly holds the U.S. asset, partnership interest, or LLC (treated as a partnership or disregarded for tax purposes) interest.

• Tax result: The investor is directly subject to:
  • U.S. tax on ECI and FDAP (with related withholding)
  • Branch Profits Tax (if foreign corporation owner)
  • FIRPTA (if any disposition of USRPI or USRPHC)
  • U.S. estate tax on U.S.-situs assets (if foreign individual owner)
  • Annual filing requirements for Form 1040-NR (individuals) or Form 1120-F (foreign corporations).
    • May require additional U.S. filings at entity level (e.g., U.S. partnership or LLC treated as partnership required to file Form 1065, related Schedules K-1 and Forms 8804 / 8805 / 8813 (withholding statements) issued).
  • Pros: No interposed entity unless desired (e.g., partnership, LLC); may reduce foreign-country complications.
  • Cons: Exposed to above-noted U.S. filing obligations and taxes and potentially no legal liability protections that would exist with a corporate structure (unless using U.S. LLC).
  • Potential use case: Small passive investments or treaty-protected portfolio holdings.U.S. “Blocker” Corporation (or LLC treated as a corporation for tax purposes)

B. U.S. “Blocker” Corporation (or LLC treated as a corporation for tax purposes)

A common approach for institutional or fund investors. The foreign investor capitalizes a U.S. C-corporation to hold the operating business, real estate, partnership or disregarded LLC interest.

• Tax result / Pros:
  • The Blocker “absorbs” ECI, paying 21% corporate income tax.
  • When profits are distributed, they are dividends subject to 30% withholding under IRC §881 (often reduced by treaty).
  • Avoids the Branch Profits Tax that would otherwise apply to a foreign corporation’s U.S. branch.
  • Potential insulation from FIRPTA (or ability for same with additional tiered structuring).
  • Simplifies compliance — the foreign owner does not file Form 1120-F or 1040-NR; only the U.S. corporation files Form 1120 (and partnership files Form 1065 if there is a U.S. partnership in the structure).
• Con: “Double” taxation — once at the corporate level and again on distribution — though effective rates can be moderated by treaty reductions or reinvestment strategies.

3. Withholding Tax & Using Treaties Strategically (Without Over-Engineering)

The U.S. imposes withholding tax on most payments to foreign persons, such as: dividends, interest, royalties, rent, service fees, and deemed branch remittances (DEA). This withholding tax is generally levied at a statutory rate of 30%, unless reduced by treaty. U.S. payors are responsible for withholding and reporting this tax via Form 1042 / 1042-S. Failure to withhold properly can shift liability for the original tax, plus penalties and interest, to the payor as withholding agent.

Treaties can dramatically reduce withholding and sometimes exempt outbound payments or business profits from U.S. taxation altogether.

Checklist for claiming treaty benefits:

1. Confirm investor’s residency certificate from home jurisdiction.
2. Evaluate specific treaty qualification articles (residency, dividends, interest, royalties, business profits, etc.).
3. Evaluate Limitation on Benefits (LOB) treaty article — are applicable requirements (such ownership and / or activity tests) satisfied?
4. Issue Form W-8BEN or W-8BEN-E to payor(s).
5. Disclose treaty position on Form 8833 if taking a treaty-based return position required to be reported.

4. Financing the U.S. Operation: Debt vs. Equity

Foreign investors often capitalize U.S. ventures through related-party debt, seeking to deduct interest while repatriating profits as interest payments (often subject to lower withholding than dividends).

Consideration:

• Debt / equity analysis (common law, and IRC §385 if applicable): Debt can be reclassified as equity, disallowing deductions and potentially creating other unintended tax impacts in certain structures.
• IRC §163(j) (generally applicable to taxpayers with average annual gross receipts of $30 million+) limits interest deductions to 30% of adjusted taxable income.
• IRC § 267 loss disallowance and matching rules regarding timing of deduction and income recognition for accrued but unpaid interest between related parties.
• IRC § 267A deduction disallowance for interest (and royalty) payments to related parties in hybrid transactions or with hybrid entities if the payment isn’t included int eh recipient’s income under foreign tax law.
• Withholding: 30% on interest, unless reduced by treaty or portfolio interest exemption applies.
  • Branch context: If the foreign corporation operates a U.S. branch, adjustments under Treas. Reg. §1.884-4 apply to determine the portion of deemed interest also subject to BPT at 30% (unless reduced by treaty), if any (i.e., the amount of excess interest not apportioned to ECI taxed at 21%).
• Base Erosion and Anti-Abuse Tax (BEAT) under §59A, which targets large corporations (generally those with $500 million+ in average annual gross receipts) making base-eroding payments like interest to related foreign parties.
• Documentation: Written loan agreements, arm’s-length terms and pricing / interest rates, contemporaneous intercompany pricing support.

5. State Tax Structuring Overlay

States have their own tax bases, nexus thresholds, and combination rules. Depending on the investment type and amount, and the state or states involved, state tax can be a material consideration.

Key Concepts:

• Nexus: Physical presence (property, payroll) or economic nexus from sales into a state.
• Separate vs. Combined Filing:
  • Some states tax entities separately.
  • Others (e.g., California, New York, Illinois) require or permit combined/unitary reporting for related entities.
• Water’s-Edge Elections:
  • Limit the combined group to U.S. members (and certain CFCs).
  • Usually binding for 7 years (Cal. Rev. & Tax Code §25113).
  • Must be modeled carefully — including impacts on foreign tax credit planning and apportionment.

Practical tips:

• Where possible, isolate U.S. operations in one entity (or the fewest otherwise necessary entities) per state nexus profile.
• Consider flexibility in deployment of property / assets, debt, and people in context of state credits and incentives, state apportionment, net worth tax, and separate vs. combined or unitary reporting rules.
• Evaluate broader U.S. legal entity structure in multi-state operating structures (e.g., corporate holding company with use of wholly-owned disregarded / flow through LLCs or subsidiary corporations) for potential state tax planning or simplification.

6. Key Takeaways

• Start with cash return in mind. Structure for efficient repatriation.
• Contain ECI. Blockers or treaty planning can reduce compliance and tax cost.
• Limit BPT exposure. It’s often the hidden double tax.
• Remember FIRPTA. Structure real estate holdings to avoid FIRPTA.
• Treaty benefits aren’t automatic. Evaluate, document, and claim them properly.
• Don’t ignore state rules. Multiple states with differing rules can complicate matters, determine materiality and perform tax impact diligence and identify opportunities accordingly.

A well-planned structure can provide legal protections and tax efficiencies.

Coming Next

Part 3: Operating and Repatriating Profits: In our next article, we’ll explore what happens once the investment is operational: withholding regimes, filing obligations, profit distributions, and how to repatriate capital without triggering unnecessary tax.

Missed Part 1? Read it here.

Thinking about investing in the U.S.? Start with a consultation to evaluate your company’s readiness and identify strategies for success. Connect with Nick Eusanio, Tax & Compliance Partner at DBL Law, to learn how proper tax planning and investment structure can help you achieve the best possible outcome.