How Does Branch Profits Tax Work In The US?

If you're a foreign company doing business in the United States through a U.S. branch, there's a unique tax you need to be aware of, which is the Branch Profits Tax (BPT). While corporations typically pay the standard corporate income tax on their U.S. earnings, the BPT adds another layer, specifically targeting foreign corporations.

It’s basically the IRS’s way of making sure that profits from U.S. operations aren’t quietly funneled out of the country without a fair share going to Uncle Sam. Essentially, the tax applies to what’s considered "dividend-equivalent amounts” profits that would have been taxed if the U.S. branch had been a subsidiary paying dividends.¹

So let’s take a look at what branch profit taxes are in the U.S. and how they work, so you can better understand your requirements as a business owner.

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What is the branch profits tax?

If a foreign company does business in the U.S. through a branch rather than a subsidiary, it might face something called the Branch Profits Tax. Think of it like this: when a U.S. subsidiary pays dividends to its foreign parent, there's usually a withholding tax. The BPT is the IRS’s way of applying a similar tax to profits from a U.S. branch, even though no dividends are paid.¹

Here’s how it works: after the foreign company pays regular U.S. income tax on its effectively connected income (ECI), the remaining profit, the "dividend equivalent amount," can be taxed again at a 30% rate (or less, if a tax treaty applies).² This discourages companies from using branches to avoid withholding taxes.

So with that being said, the U.S. treats branches somewhat like subsidiaries for tax purposes, just to make sure profits leaving the U.S. don’t slip through untaxed.

How does it differ from regular corporate tax?

Branch profits tax is a bit different from regular corporate tax. Regular corporate tax applies to all U.S. corporations on their profits, pretty straightforward. But when a foreign company operates a U.S. branch instead of setting up a separate U.S. subsidiary, things get more complicated. The branch still pays regular corporate tax on its income, but then the IRS adds an extra layer: the branch profits tax.

Why? Because if the company had a U.S. subsidiary, any money sent back to the parent would be taxed as a dividend. So, the branch profits tax is the IRS’s way of making sure that foreign branches don’t get around that second layer of tax.

Why was the branch profits tax introduced?

The branch profits tax was introduced to close a tax loophole. Before it existed, foreign companies could operate in the U.S. through a branch instead of setting up a U.S. subsidiary, and avoid paying certain taxes that American companies or foreign subsidiaries had to pay. Basically, they were able to pull profits out of the U.S. without getting hit with the usual dividend tax.¹

The IRS saw this as unfair and created the branch profits tax to level the playing field. Now, even if a foreign company uses a branch, it still pays tax on profits as if it were sending a dividend to its parent company. It helps make sure everyone is taxed equally, no matter the structure.

What is the “dividend equivalent amount”?

The “dividend equivalent amount” is a fancy tax term, but it’s actually pretty straightforward once you break it down. When a foreign company operates in the U.S. through a branch (instead of setting up a separate U.S. corporation), the IRS still wants to tax what it thinks would’ve been sent back to the foreign parent company, like a dividend.

That’s where this term comes into play. It’s the amount of U.S. earnings the IRS figures would’ve been distributed if the branch were a subsidiary. That number becomes the basis for the branch profits tax. So even if no money is actually sent home, you could still owe tax on this “as-if” distribution.³

Is every company branch subject to the profits tax?

Not necessarily. Whether a company branch is subject to profits tax depends on a few factors. In general, if the branch is earning income from business activities carried out in a particular country (like Hong Kong, for example), it may be subject to that country’s profits tax. The most important factor here is where the profits are derived from. If a branch operates locally and earns income from that location, it’s usually liable. But if the branch doesn’t actually conduct business or generate profits in that country, then it might not be taxed there.

Also, tax treaties between countries can influence this; some may offer relief to avoid double taxation. So, it really comes down to where the income is generated and whether the branch is seen as having a permanent presence for tax purposes.²

Which entities are considered branches?

When we talk about “branches” for U.S. tax purposes, we’re really referring to a part of a foreign company that’s doing business directly in the U.S. but not set up as a separate U.S. corporation. So, if a foreign company opens an office, factory, or even just has employees working regularly in the U.S., that could be considered a U.S. branch.

The IRS examines whether the foreign company has a “permanent establishment” in the United States. If it does, then the branch profits tax might apply. So yes, you can be a “branch” without even realizing it, and that’s why it’s important to understand how this works.

Does having a U.S. office automatically trigger the tax

Just having a U.S. office doesn’t automatically mean you’re hit with the branch profits tax, but it can definitely be a step in that direction. The most important factor here is whether your business has a “U.S. trade or business” and generates effectively connected income (ECI).

If that’s the case, then the IRS may treat your U.S. operations as a branch of your foreign company, which could trigger the branch profits tax. So, while simply opening an office won’t always do it, what you do through that office matters ¹

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Are there exceptions to the branch profits tax?

Yes, there are exceptions. Here’s a look at the most common exceptions to branch profit tax:

• Reinvestment of Income
  • If profits are reinvested in the U.S. rather than repatriated to the foreign corporation’s home country, the branch profits tax may not apply.⁴
• Tax Treaties
  • Income tax treaties between the U.S. and certain countries can reduce or eliminate the 30% branch profits tax. ⁵
  • Countries like the UK, Germany, and Canada often have reduced treaty rates (e.g., 10% or 15%).⁶
• Complete Termination of U.S. Business
  • If a foreign corporation fully terminates its U.S. trade or business and files the required documentation, it may avoid the tax.⁴
• Treaty Qualification Requirements
  • To benefit from treaty-reduced rates, the foreign corporation must qualify for and claim the treaty benefits.⁵
  • This involves reviewing the latest IRS Tax Treaty Table 1 and ensuring proper compliance.⁶

What documentation is needed to claim a treaty benefit?

To claim a treaty benefit for the branch profits tax, you’ll need to provide the right documentation to the IRS. The most important form is IRS Form 8833 (Treaty-Based Return Position Disclosure), which tells the IRS exactly which treaty you’re relying on and which article applies.

You’ll usually file it along with Form 1120-F, which is the U.S. tax return for foreign corporations. You also need to make sure you’re properly documenting residency in the treaty country. Missing any of this could mean you lose the treaty benefit and end up paying the full 30% tax.¹

What’s the branch profits tax rate?

If a foreign corporation does business in the U.S. through a branch rather than a subsidiary, it might be subject to the branch profits tax. So what’s the rate? It’s 30%, but here’s the catch: that’s 30% on the “dividend equivalent amount.” Think of that as the money the IRS assumes the branch would’ve sent home to its foreign parent if it were a subsidiary paying a dividend. The idea is to level the playing field between branches and subsidiaries, so branches don’t get a tax advantage.²

Now, some good news: this 30% rate can be reduced or even eliminated if there’s an applicable tax treaty between the U.S. and the branch’s home country. Many treaties bring it down to 5%, 10%, or even 0%.³

How and when the tax is calculated and paid

The branch profits tax is tied directly to your U.S. business activity. It’s calculated annually based on the “dividend equivalent amount”, which is the U.S. branch’s earnings after regular corporate income tax, minus any reinvested amounts or prior year adjustments. You calculate and report this on Form 1120-F, the U.S. income tax return for foreign corporations.

It’s generally due on the same timeline as regular corporate returns—April 15th for calendar-year filers, with extensions available. Missing it can mean penalties or interest.²

Final Thoughts

The branch profits tax in the U.S. is designed to make sure foreign companies doing business here through a branch don’t get an unfair tax advantage over those using a U.S. subsidiary. The most important thing here is keeping good records and understanding how your U.S. operations are structured. If you’re a foreign business owner, it’s definitely something to be aware of, especially when planning how to move profits around. At the end of the day, understanding the branch profits tax can save you from unexpected costs and headaches later on.

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Sources:

1. Branch Profits Tax Concepts | IRS
2. United States Corporate - Branch Income | PwC
3. Navigating the branch profits tax | Freeman Law
4. Exceptions to branch profits tax available to foreign corporations with U.S. tax compliance obligations | The Tax Adviser
5. United States income tax treaties | IRS
6. Table 1. Tax rates on income other than personal service income | IRS