The Branch Profits Tax: What It Means for Foreign Companies Doing Business in the U.S.

Summary: Foreign companies operating U.S. branches may face the branch profits tax, which is a second layer of tax on top of regular corporate income tax. In this article, Aprio explains how the tax works, the role of tax treaties, and strategies to reduce exposure. With proactive planning, multinational businesses can avoid costly surprises and integrate branch profits tax into their global tax strategy.

When foreign companies expand into the United States, one of the first decisions they must make is whether to set up a subsidiary or operate as a branch. On the surface, running a branch feels like the “easy button” for multinational businesses; there is no need to set up a new entity, which means they can just start doing business immediately.

As with most things in U.S. tax, the “easy way” often comes with a catch. But the silver lining is that the U.S. tax code has a funny way of leveling the playing field. This is where the branch profits tax comes into play.

In short, if you’re running a U.S. branch of a business, the IRS doesn’t want you to avoid the dividend withholding tax that would normally apply if you had set up a U.S. subsidiary. Essentially, the branch profits tax is designed to mimic that result. If you don’t plan for or adjust your structure to account for branch profits tax, the extra cost can come as a surprise. In this article, we define the branch profits tax, explain how it works, and discuss planning strategies you can use to prepare proactively.

What Exactly is the Branch Profits Tax?

You can think of the branch profits tax as a second layer of U.S. tax on top of regular income tax. The process breaks down into two levels:

• Level one: First, the U.S. branch pays the normal U.S. corporate income tax on its effectively connected income (ECI).
• Level two: If those after-tax profits are pulled out of the U.S. or the business does not reinvest them, the IRS will assume that amount is a dividend. Therefore, to get their “bite” of the tax apple, the IRS imposes a 30% branch profits tax on this dividend equivalent amount.

Essentially, the “dividend equivalent amount” is the IRS’s technical way of calculating:

• Profits earned by the branch;
• Minus any profits left behind in the U.S. to reinvest; plus
• Any money pulled out of the branch, like repatriating cash or reducing U.S. equity.

From there, if the business invests the money in the U.S., the branch profits tax does not apply specifically on that U.S. invested income, for that year. Conversely, if the business takes the money out of the U.S., the branch profits tax will be applied by the IRS.

The Branch Profits Tax and Tax Treaties: What is the Connection?

Many U.S. tax treaties reduce the usual 30% branch profits tax rate to a lower rate. In many cases, treaties will reduce branch profits tax to 5% or even 10%; sometimes the treaties will eliminate the tax entirely, depending on which countries are involved. This can be a huge tax boon to multinational businesses operating across borders.

For example, under the U.S.–Germany tax treaty, the branch profits tax rate can drop drastically down to 5% if the branch qualifies for Limitation on Benefits (LOB) rules. These rules are in place to prevent businesses from “treaty shopping” for the best treaty rates. But if the branch meets the LOB rules, it essentially will be in the same position as a U.S. subsidiary paying a dividend to a German parent, where treaty-dividend withholding is also taxed at 5%. In most cases, the branch will need to disclose this position on Form 8833.

Example: The Branch Profits Tax in Action

Let’s say that a German manufacturer sets up a branch in the U.S. In 2024, the branch had a good year and earned $5 million of ECI. After paying the regular U.S. tax, the company has $3.5 million left over.

If the company uses this extra $3.5 million to buy new equipment and expands its U.S. plant, then it will not be subjected to branch profits tax for that year. However, let’s say that the parent company takes $2 million out of the U.S. and repatriates it to Germany — in that case, the $2 million will be treated like a dividend. At a 30% rate, the company will have to pay an extra tax of $600,000.

Assuming the company qualifies for the appropriate rules under the U.S.–Germany tax treaty, its tax rate will drop to 5%, meaning the tax owed will drop to $100,000. This example illustrates just how big of a difference tax treaties can make to companies subjected to branch profits tax.

It bears repeating that multinational companies should enlist the help of a qualified, globally proficient tax advisor to properly assess branch profits tax liability and the impact of specific treaties on the applied rate.

Important Tax Planning Tips for Multinational Businesses

Outside of tax treaties, there are other strategies and tactics businesses can deploy to potentially reduce their branch profits tax exposure. These strategies include:

• Comparing structures early: Sometimes it makes more sense for companies to set up a U.S. subsidiary versus a branch, and vice versa. That’s why it’s crucial for you to run the numbers upfront for both scenarios; you’ll save yourself a headache down the road.
• Reinvesting where possible: By leaving profits in the U.S., you can often defer branch profits tax and devote more funds toward supporting your business’s future growth.
• Watching withdrawals: Keep in mind that any withdrawal — even debt repayments to your parent company — can trigger branch profit tax in certain cases.
• Using treaty benefits wisely: Don’t assume you qualify for tax treaty benefits automatically. Pay close attention to the LOB rules and be sure to flag treaty benefits on Form 8833 accordingly. Enlist the help of a qualified CPA early to prevent any missteps.
• Thinking about your exit strategy: In the past, we’ve seen clients close a branch, only to get hit with a final branch profits tax bill because everything they left in the U.S. was “deemed” repatriated. Develop a proactive plan for exiting your branch in case you decide to cease operations.

Why Does Branch Profits Tax Planning Matter?

The branch profits tax often flies under the radar because many businesses primarily focus on Form 1120-F and regular income tax compliance. But it’s important to recognize that the branch profits tax can be just as significant in cases where you’re pulling profits back overseas.

The good news? With the right planning, branch profits tax compliance doesn’t have to be painful. The key is to understand how it works, know when and where treaty relief comes into play, and integrate your plans into your U.S. tax strategy from the outset.

Final Thoughts on the Branch Profits Tax

You don’t have to navigate global tax compliance alone. Aprio’s International Business Tax Services team is here to help you cross borders with confidence and clarity. From transfer pricing and global tax strategy to customs & tariffs and global mobility solutions, we specialize in helping businesses establish and scale their operations with efficiency.