Ways U.S. Colleges and Universities Can Reduce Tax Liability and Risk Generated By Foreign Research and Study Abroad Programs
As economies globalize and more knowledge is being shared, institutions of higher education have had to globalize their learning and research programs as well, and they are learning, sometimes the hard way, that the rules they are so very familiar with in the U.S. do not apply outside of our borders. The world is very different for tax-exempt organizations once they expand their presence outside the U.S. because often the tax-exempt status they enjoy here is not applicable abroad. Once they have personnel working outside the United States, most universities and research institutes have to deal with new areas of tax and law. For example, they are now likely subject to income taxes, tax on their employee’s income, tax on the employee, foreign employment laws, value added tax (VAT) and other indirect taxes, exchange controls, and a host of other possible legal and tax rules. Often, being in full compliance with all these various rules is a condition placed on the grants used to fund these learning and research programs.
The solution is to stay in front of the problem. When these issues arise later, they are expensive because the penalties, interest and taxes have usually mounted for several years before the tax authorities in the foreign jurisdiction catch the problem. This can really cause a big stink with regards to public relations for an institution and protecting a college or university’s reputation is essential to its growth and survival. This is certainly a situation where an ounce of prevention is better than a pound of cure, except here, often there really is no cure beyond paying the taxes and fines and enduring the embarrassment.
Our team has helped to advise universities and research programs on ways to manage and prevent the global legal and tax issues that arises from study abroad and foreign research activity. In our experience, there are several lessons unique to tax exempt organizations that must be addressed. Many of the most fundamental problems that seem to occur in these programs result from a lack of communication. Some part of this is due to the institution’s desire to support the independent environment needed to foster research and innovation, while another part is driven by the need to keep discoveries secret until patent protections are in place. This fosters an environment where the administrators of a university do not always know all the details surrounding these research activities.
Add to this the free spirited nature of scientists, and at many institutions, the extent of a foreign research project becomes known to finance and accounting only after a large tax assessment or garnishment occurs. Only then do administrators learn that a research fellow, pursuant to a grant, went to Mozambique with a suitcase full of cash and a bunch of traveler’s checks to conduct malaria research, and proceeded to buy equipment, trucks (no insurance of any kind), supplies, hire personnel (paying them cash and not filing any payroll) and rent office and apartment space. This is not a fictitious example, it really happened. These types of activities establish an income tax presence in most jurisdictions and create income tax liabilities, payroll tax liabilities, employment tax liabilities, potential employment law violations, general liability for vehicle usage, possible worker safety liability, and other value added tax (VAT) and indirect tax related issues.
Even if you are not buying equipment or hiring people, income tax problems arise when a person, company, or organization is pursuing a trade or business from a fixed location in a country. Unless you are a tax professional or have some training in tax related issues, you are not likely to realize that a dig, a clinical laboratory, a classroom, an office, even a hotel room can be “fixed locations” or that a “trade or business” is very broad and generally includes any economic activity. Generally, once one of these problems has occurred, it cannot be undone.
There is good news however! We have learned that one very effective method to mitigate and manage these risks is by educating the department heads and researchers on the potential issues and by relying on the program participants and managers themselves to regulate behavior and make sure that proper structuring and risk mitigation have been considered before foreign research or study programs are started. Additionally, by relying on the treaties between the U.S. and the foreign jurisdictions, we can usually develop a plan and draft policy statements that reduce or eliminate the risk of activities becoming a taxable presence. There are known techniques to reduce risk of income taxes, comply with employment law and manage general liability. Often times all these risks can be managed and maintained in a way that keeps the exposure and risk very low, but it requires upfront action by the institution.
We generally follow several simple rules:
1. Do not assume your activity would be viewed as non-taxable. If fact, assume the opposite. If you are charging money in exchange for services, such as educational services in the case of study abroad programs, and you are doing it from a place, like a classroom that is in a building, you have a tax presence (also known as a “PE”, for “permanent establishment”). Having a tax presence means you need to pay tax on a profit. We have structured certain programs to make sure they do not technically have a profit. This means (1) you can argue that you do not have a taxable presence because you do not have a “business” since there is no profit motive, and (2) if there is a PE, you do not have any profit aligned to it.
2. Break down silos. Develop a process to get information about research activities, study abroad programs and offshore campuses to the administrative departments. We have found that organizationally, universities can be very siloed. Information is in pockets of places. Research programs are highly decentralized and far from accounting. Grants are handled far and away from finance and accounting. Information at an administration level is not well shared, especially when it comes to research.
3. Address indirect taxes, such as value added tax (VAT), goods and services tax (GST), or harmonized sales tax (HST). Your institution will be paying indirect tax on almost all its services, utilities, short term accommodations, equipment rentals, and so on. With proper filings and documentation, there are often ways to recover the indirect taxes your institution pays. There is no reason for an indirect tax to become an additional cost, but to avoid this the boots on the ground and program managers need to understand how it differs from U.S. sales tax, what services and products are subject to these taxes, and the documentation they need to maintain.
4. Mitigate risk whenever possible. There are many established tools that can mitigate tax, treasury and operational risks. For example, properly structured contracts with independent agents, and having a “PE blocker” entity in the organizational structure that employs the employees in the foreign country can significantly reduce HR and tax risks to the college or university. Risk mitigation needs to begin in the planning phase.
5. Focus on developing a process that can be managed from the center, but operated from the field. It will always be difficult for legal, finance and accounting to monitor the activities of scientists and professors. The very nature of their work at times requires them to be a group of mavericks. We have found that with training and a clear communication process we can prevent big problems. Generally, we advise training researchers. It is impractical to think you can control the program from thousands of miles away, so empower them with the knowledge they need to manage the program themselves. Provide them the rules in a straight-forward format and make it easy for them to get answers to questions that arise.
6. Pay attention to important federal and international laws and embargos under OFAC, ITAR, FCPA and other international anti-corruption law, like the UK Bribery Act. For example, care must be taken if you are engaging in any type of export (including temporary export such as traveling with equipment) with Russia and occupied Crimea, Belarus, Cuba, Eritrea, Iran, North Korea, Syria, Venezuela. Additionally, under the UK Bribery Act, commercial bribery may include rebates, commissions and other returns to buyers can be illegal.
7. Keep up with tax rules as they evolve with technology. For example, Distance Learning and Mass Open On-line Courses (“MOOCs”) may increase an institution’s tax footprint. Both formats create the same problem because they could likely be classified as digitally delivered services under various evolving tax regimes. The rules for indirect taxes and income taxation are rapidly evolving and the emerging trend is to tax the “economic activity” of a digitally delivered services at the point of the customer or client. While educational training may be exempt under some regimes, it is possible this will not be the case in all jurisdictions. We highly recommend having an administrator monitor evolving tax rules in the jurisdictions where classes (virtual or brick and mortar) or research activities are conducted and to be educated on the potential issues that may arise
In conclusion, by getting in front of the issues and risks and using well established risk mitigation techniques, an institution of learning and research can manage down risk to very low levels. To succeed in this, it takes leadership and a tone from the top.
BILTgroup is a law firm focused on the practice of international law and tax. We can help your college or university design, implement, and document a plan that is efficient and easy to replicate as your organization expands around the globe. If you are curious to see how we may be able to help your growing institution or have any questions, please contact us at 919-615-3766 or by email gbryant@BILTgroup.net.