When U.S. investors consider investing in a non-U.S. portfolio company, sometimes they might not fully consider or appreciate the significant differences that can exist in accounting, reporting, tax and regulatory standards between the United States and foreign countries.
In doing proper due diligence on a non-U.S. Company, it is critically important to understand all of the unique foreign country rules and standards, as well as the differences that U.S. investors need to understand when U.S. funds are invested in and repatriated from a foreign entity.
This article is intended to cover on a macro basis some of the considerations U.S. investors should take into account as part of their due diligence process when considering an investment in a foreign enterprise.
Accounting and Reporting
The first issue to be aware of is that U.S. Companies report on U.S. GAAP ( generally accepted accounting principles). Believe it or not, the only country in the world that reports on “U.S. GAAP” is the United States. Every other country reports on either some modified form of GAAP, or, most commonly, IFRS (international financial reporting standards). IFRS is generally considered the standard for international reporting and is used by approximately 150 countries worldwide.
While there is massive complexity, nuance and detail to all countries’ accounting standards, the differences between U.S. GAAP and IFRS are dramatic. Fundamentally, U.S. GAAP is “rules based” with reporting generally based on “historical cost” less depreciation and amortization. IFRS, on the other hand, is “principles based” essentially reporting on a more “fair value” or “mark to market” type basis and generally provides greater flexibility on reporting for transactions based on their substance and transparency ( ie, not rules based).
When comparing U.S. GAAP TO IFRS, one cannot underestimate the significant differences that can exist in major income statements or balance sheet accounts, different standards for revenue and expense recognition, inventory costing and methods, consolidation of subsidiaries and joint ventures, treatment of hedging transactions, just to name a few.
Tax Regimes
While it likely goes without saying, each country’s tax regimes are unique and different. It is too long and complex a topic to try and elaborate at other than the most basic level. That being said, a few of the most basic considerations – corporate tax regimes can vary widely; not just tax rates but also:
deductibility of items,
methods of accounting (cash or accrual or modified),
inventory methods,
revenue recognition,
availability or not of carryback and carryforward losses (particularly relevant in early stage companies).
In Europe, as an example, a significant part of the taxing regime is the VAT (value added tax) which is a national type sales tax imposed on most inventory items and retail sales. No similar national tax is imposed in the U.S., although there are local sales and use taxes that could be imposed at the state level.
Similarly, one has to be aware of some of the major tax differences that could occur particularly upon sale of Company shares and/or repatriation of dividends or income back to the U.S. Often, gains on sale of companies could be subject to both U.S. and foreign country taxation, resulting in the need to understand foreign tax credit rules in the U.S. to avoid or minimize double taxation. Similarly, sales of Company shares could be subject to mandatory foreign withholding tax in the foreign jurisdiction.
Dividends may also be subject to mandatory “withholding” tax at source ( ie , the foreign country) reducing the actual amount of cash received on any distribution to the U.S. shareholder.
In addition to the technical rules, the United States and many Countries have mutual “tax treaty” provisions that could result in a modification, or special treatment, or items of income, gain or sale on funds that are repatriated to the U.S..
Lastly, and just to make a point, many might have seen the recent Supreme Court decision in “Moore vs. the U.S.” ( June 20, 2024) where a U.S. couple that owned stock in a foreign company was taxed on their share of that foreign Company’s income without ever having received any cash distributions with respect to that income in that year. The court held that the “taxation of unrealized income was in fact valid, that it was “income” to the U.S. taxpayer, and they had to pay U.S. income tax on that “accrued” amount without ever having received any cash from the investment.
Obviously, there were specific facts in this case, related to specific rules in the tax law, ( ie , this rule does not apply to all U.S. shareholders of foreign companies), however, it’s a good cautionary tale of how you need to “expect the unexpected” when dealing with the complexities and vagaries of U.S./foreign taxation.
Regulatory Considerations
Every foreign country has their version of the U.S. Securities and Exchange Commission (SEC) , and their version of regulatory rules, corporate and management fiduciary responsibilities, and shareholder protections. In doing due diligence on a foreign registered Company, it is important to understand that country’s regulatory landscape. While early stage companies may often fall below the scope of the much of that country’s regulatory regime, they may not be exempt, and U.S. equivalent type rules around “accredited investors” or reporting by registered investment advisors may come into play.
Advisors
Sometimes there is a tendency, especially when first starting to invest in foreign companies, to try and “do it on your own”, or believe it is not that much different and you can figure it out yourself. My advice after 40 years of experience – DON’T DO IT! It is critically important to have local legal counsel especially for corporate, securities and regulatory matters and of course accounting advisors whose expertise is those countries’ accounting and reporting framework. It also is generally necessary to have someone who is familiar with valuation techniques and methodologies in the local jurisdiction, although this can possibly be your legal or accounting advisors.
Final Word
This article is not intended as any type of technical or comprehensive outlook as you begin to consider your investments in a foreign entity. Maybe more like a “word to the wise”.
Good luck to all who begin to go down the path of investing in foreign entities. It is important to be particularly cautious and sensitive to the differences that will exist. Don’t try and go it alone and make sure your team includes competent local counsel and other necessary local advisors.
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