The gaming industry is a global industry. Gaming companies operate land-based casinos in multiple countries, ranging from Nevada to Macau. Internet-based gaming (iGaming) offers gaming opportunities for wagerers residing in various nations through a single Internet site. The fallout from the ongoing economic malaise may increase cross-border investments as struggling gaming businesses seek to attract new sources of capital. The prospect that iGaming may be authorized in some form in the U.S. may also lead to foreign businesses launching new operations in the U.S. Structuring cross-border investments of gaming businesses raise numerous international tax considerations.
Structuring a cross-border investment in the gaming industry not only requires an examination of the gaming laws of particular countries, but also the tax implications of investing in and operating an international business. Structuring a relatively straight-forward cross-border business transaction in the same fashion as a similar wholly-domestic transaction can lead to tensions that produce disastrous international tax consequences. This article focuses primarily on international tax planning from the perspective that U.S. tax laws are implicated. The typical transaction can range from the formation of an iGaming business by U.S. and foreign investors through a domestic U.S. business entity; an investment by a U.S. corporation in a Macau land-based casino, or a foreign domiciled gaming equipment manufacturer expanding operations to the United States. Although each business deal presents unique facts and circumstances—which could require adopting different transactional structures—the tax analysis starts with an examination of a common set of topics. This article provides a high-level overview of international tax planning considerations with cross-border gaming businesses.
Identifying the Participants, Residency and Place of Operations
The threshold task is to identify the universe of the gaming business. This task involves identifying: (1) the residency of the investors; and (2) the jurisdictions where the business activities will take place. The purpose of this first task is quite simple: Knowing the residency of investors and where the business will carry on its activities allows for the identification of the laws and tax treaties that may be implicated. For example, suppose a Canadian gaming business and U.S. software company desire to start-up an iGaming business in the United Kingdom. Knowing the investors are residents of Canada and the United States directs that U.S. and Canadian tax laws must be considered. By also knowing that the business will operate, and potentially generate revenue, in the United Kingdom, United Kingdom tax laws, together with the U.S.-United Kingdom and Canada-United Kingdom income tax treaties must also be reviewed.
International Tax Implications for Structuring Business Operations
International tax issues can vary remarkably depending upon whether the business activities will take place in the U.S. by foreign investors, perhaps in conjunction with U.S. co-investors, or in a foreign country by U.S. resident taxpayers. As a general starting point, the U.S. has adopted a worldwide approach to taxing income of U.S. taxpayers. Other nations may also use the worldwide system of taxation. U.S. and foreign tax laws provide a complex set of rules, which can produce different results, based on minor differences in business structures.
In structuring cross-border business operations, choice of entity decisions can serve as an initial decision-making point. Choice of entity considerations raises two distinct issues: the country to organize the business entity and the type of business entity to use. From a tax planning perspective, the fundamental goals necessarily involve implementing structures that eliminate double-taxation and address the timing earnings will be taxed to the investors.
Selecting a Jurisdiction for the Operating Entity
The jurisdiction selected to organize a business entity will often turn on the location principal business activities will be conducted. For instance, if a domestic U.S. corporation enters into a joint venture with a French corporation to operate an Atlantic City casino, from the perspective of U.S. taxpayers, it will be highly desirable to use a domestically organized business entity. Nearly all the revenue-generating business activities will be conducted in the United States and, thus, generally subject to U.S. taxation. Accordingly, there are limited tax incentives to organize the operating entity in a foreign jurisdiction. If a foreign corporation is used, there could be exposure to the U.S. branch profits tax, an additional layer of tax on distributions and denial of the ability to generate tax credits arising from the payment of U.S. taxes.
In the alternative, if the business activity will primarily be carried on in a foreign nation, it may be more tax efficient to use a foreign business entity to carry on the business. Consider the example of an iGaming business that may generate revenue from several different jurisdictions. Under such circumstances, there may be good business and tax reasons to organize the business entity in a foreign country. The specific type of foreign entity used can also impact U.S. tax liability. For instance, a foreign business entity that is classified as a corporation may allow for the deferral of U.S. taxation to shareholders if the foreign corporation is not a “controlled foreign corporation” (CFC) for U.S. tax purposes. On the other hand, if significant operating losses are anticipated during the start-up phase, the use of a foreign partnership may be desirable in order to have the losses currently passed through. The particular facts and circumstances of the cross-border business dictate the selection of a jurisdiction to organize the business entity.
Inbound Investments in Business Activities Conducted in the U.S.
Assuming that the business activity will primarily be in the U.S. and the investors have opted to carry-on the business through a domestic U.S. entity, most U.S. taxpayers invariably desire to use an entity taxed as a partnership for U.S. federal income tax purposes. The benefit of the U.S. partnership tax regime is that only a single layer of tax applies to the business activity. That is, no entity level tax is imposed on entities classified as “partnerships” for U.S. tax purposes1. In contrast, domestic corporations generally are taxed at the entity level. Thus, earnings are subject to double taxation: first, at the corporate level at the time income is earned and, second, when earnings are distributed to shareholders.
For the foreign investor, the use of a domestic entity raises a question with respect to the means to hold the ownership interest in the domestic entity. The foreign investor has the option of holding the investment directly or interposing a subsidiary to hold the investment. The ownership structure will often turn on whether it is more tax efficient to consolidate income with other U.S. business activities or foreign activities and the U.S. tax treatment of a subsequent sale of the ownership interest. There are frequently other business reasons separate from tax considerations that make it desirable to interpose a subsidiary to hold the investment in the U.S. operating business.
Depending on the foreign investor’s tax position, there may be a number of alternative ownership structures that can be utilized. These structures could include holding the ownership interest through an existing U.S. subsidiary, forming a standalone U.S. subsidiary or a foreign subsidiary. In some situations, depending on home country tax treatment, it may be appropriate to use a hybrid entity, which is treated as a partnership for U.S. tax purposes and a corporation for foreign tax purposes. The varying tax implications can be illustrated by the following example: Deep Pockets, a Canadian corporation, and Vegas Gaming, a U.S. corporation, will equally own the Strip Casino, situated on the Las Vegas Strip. Deep Pockets and Vegas Gaming form a U.S. partnership, Operations, L.P., to own and operate Strip Casino.
Scenario 1
Deep Pockets is investing on a short-term basis and will sell its interest in Strip Casino within two years. Deep Pockets primary motivation is to avoid U.S. tax on the sale of its interest in Strip Casino. Deep Pockets may opt to hold its interest in Operations, L.P. through a newly formed corporation. To avoid the complex U.S. interest allocation rules and branch profits tax, Deep Pockets could incorporate a U.S. corporation to hold its interest in Operations, L.P. Figure 1 illustrates this ownership structure.
Scenario 2
Alternatively, suppose Deep Pockets has other U.S. business interests that generate significant profits. Deep Pockets expects Strip Casino to have operating losses over the next several years. Deep Pockets may wish to consolidate its share of Strip Casino’s operating results with its other U.S. business activities for U.S. tax purposes. To that end, Deep Pockets may use an existing U.S. corporation to hold its interest in Operations, L.P. Figure 2 illustrates this ownership structure.
Outbound U.S. Investments in Foreign Businesses
There are numerous international tax issues when a U.S. taxpayer conducts business activities overseas. The structure of the overseas business activities—for example, operating as a foreign branch or organizing a foreign corporation—directly impact the U.S. tax treatment of overseas activities. Additionally, if foreign investors partner in the overseas business activity, the business deal may dictate transactional structures that produce varying U.S. tax treatment. The tax analysis will often turn on whether a tax treaty has been entered between the U.S. and the foreign nation where the business activity takes place.
Common issues that are considered when structuring a foreign business activity conducted by a U.S. taxpayer include:
1. foreign taxes and tax rates applicable to the business activities;
2. the form of the business entity and the tax treatment of the entity for both foreign and U.S. tax purposes. For example, will the earnings of the foreign business be currently taxed in the U.S. and the foreign country;
3. the nature of contributions to the business entity and the corresponding U.S. and foreign tax treatment of contributions;
4. withholding rates for payments such as dividends, royalties and interest, by a foreign person to U.S. investors;
5. whether the U.S. foreign tax credit will be available;
6. if the foreign entity is a corporation for U.S. tax purposes, whether the foreign corporation will be treated as CFC for U.S. tax purposes;
7. how to structure a U.S. investor’s ownership interest in the foreign business entity; and
8. U.S. tax treatment of the distribution of earnings to U.S. taxpayers.
At the planning stage, there are a number of proactive steps that can be taken to structure the business operations to minimize the tax exposure. There is no one-size-fits-all structure for cross-border business transactions. As highlighted above, the particular facts and circumstances can lead to the use of different transactional structures. The specific terms of the business deal will ultimately drive the tax analysis and the structuring decisions.
Conclusion
Tax planning for international business activities in the gaming industry requires careful analysis of complex U.S. international tax laws provisions and, if applicable, tax treaties with foreign nations. There are several factors that can influence the use of a particular structure for a cross-border gaming business. The starting point is to understand the universe in which the business will operate—what country or countries will business activities take place, identifying investors and their residency are all important facts that must be known to properly consider the tax consequences of a business structure. Armed with this basic knowledge and with an understanding of the business deal, a tax efficient strategy can be implemented. There is no one singular approach that will work with all cross-border business; rather, as outlined above, the particular facts of each business will help guide structuring a tax efficient business structure.
Footnotes
1 The “limited liability company” has increasingly become the most desired form of business entity in the U.S. because it offers limited liability protection similar to the corporate solution and can be classified as a partnership for federal tax purposes. A multi-member limited liability company, by default, is treated as a partnership for U.S. federal tax purposes. Use of a limited liability company may, however, have adverse tax consequences for foreign investors in their home country.