This article is intended for non-U.S. investors who are considering expanding operations to the U.S. through a U.S. entity and provides a broad overview of the steps for formation of a U.S. entity and initial legal considerations to assist with the process of expansion. The article also provides guidance on the role that U.S. counsel should play in the process of forming and operating a company in the U.S. This is a broad overview of the topic, does not include many material issues that will also need to be considered and should not be considered as a substitute for receiving guidance from competent U.S. counsel.
Restrictions on Ownership by Non-U.S. Investors of a U.S. Company
With a few narrow exceptions, the ability of non-U.S. investors to form U.S. companies is the same as those of a U.S. investor. The exceptions to this ability include restrictions on ownership by non-U.S. investors of companies operating in particular industries, such as communications, nuclear power, air carriers and intra-coastal merchant vessels, as well as on acquisitions of banks or bank holding companies, or primary dealers in U.S. government securities. Typically, companies that will operate in these industries are required to obtain a license from the U.S. government to operate in the industry, and federal law limits non-U.S. ownership of such licenses. The U.S. government also has broad authority to suspend or prohibit acquisitions of U.S. companies by non-U.S. investors if the acquisition is deemed to impair national security, although as of February 14, 2020, only five transactions have ever been formally prohibited by the U.S. on national security grounds.
Additionally, the Foreign Investment Risk Review Modernization Act of 2018 (FIRMA) also subjects certain types of non-U.S. investments in U.S. businesses to review by the Committee on Foreign Investment in the United States (CFIUS), therefore, if expansion into the U.S. will be through investment into an existing entity rather than formation of a new entity, these rules will need to be considered, along with other reporting requirements that could apply to such an investment such as the reporting requirements under the International Investment and Trade and Services Survey Act that apply when a non-U.S. investor acquires 10% or more of a U.S. company’s voting securities.
Choice of Entity in the U.S.
The five most common types of entities in the U.S. are (1) the sole proprietorship, (2) the partnership (general, limited, or limited liability partnership), (3) the S corporation, (4) the C corporation, and (5) the limited liability company (“LLC”). There are a number of factors that influence the choice of entity decision, including tax and financial considerations, liability protection and management structure, each of which will be discussed below.
Tax and Financial Considerations. Tax considerations play a key role in choice of entity and have an impact on the amount of an entity’s tax liability and the structure and efficiency of its tax filing obligations. Thus, the first step for choice of entity should be consultation with a U.S. tax advisor who can advise on these issues.
A comprehensive discussion of the tax considerations involved in choice of entity is well beyond the scope of this article, however, as a general matter, C corporations are subject to a separate tax on their earnings and a second tax is then imposed on shareholders when earnings are distributed. In contrast, pass-through entities such as S corporations, partnerships and LLCs are only subject to a single level of tax as profits and losses are passed directly through to owners.
Choice of entity also impacts who will be responsible for filing U.S. tax returns. In general, if a non-U.S. investor owns a direct interest in a pass-through U.S. entity (i.e. a partnership or LLC), it will, itself, have a direct U.S. tax filing obligation. In contrast, if a non-U.S. investor owns a direct interest in a U.S. C corporation, the C corporation itself will have the tax filing obligation.
Additionally, there are a variety of financial considerations that impact choice of entity such as manner in which the company plans to raise and manage money. For example, if a company plans to raise capital by publicly selling shares of its stock it will need to choose a corporation rather than a partnership or LLC since pass-through entities typically do not have interests that are publicly sold.
Liability Protection. The amount of liability protection available to investors in the U.S. varies depending on the type of entity selected. In general, corporations and LLCs limit the liability of investors to the amount of their investment, while partnerships only provide liability protection for limited partners and not general partners. Thus, if a business presents a high level of risk (e.g. exposure to substantial tort or contract liability), an LLC or corporation will be more attractive than a partnership, particularly if the non-U.S. investor has a significant amount of wealth outside the U.S. business that needs to be protected. However, the same level of liability protection available through corporations and LLCs can be achieved through a partnership by having a corporation or LLC serve as its general partner. Additionally, the particular state laws that govern liability where business will be conducted should also be considered in the choice of entity analysis, since state law often determines the scope of liability protection which can vary greatly, in particular for limited partnerships and limited liability partnerships.
Management Structure. Management structures differ based on choice of entity. In general, corporations tend to be managed by a board of directors and corporate officers who are appointed by the shareholders of the corporation. LLCs tend to be managed either by its members or by a board of managers and typically have greater flexibility than corporations in terms of how management can be structured. Partnerships are typically managed by one or more general partners.
Formation of a U.S. Entity
Once the type of entity is selected, the process of forming the entity and preparing the necessary corporate governance documents can begin. Below is an overview of the initial steps and documents that will need to be prepared in connection with the formation of an entity in the U.S.
Formation at the State Level. Entities in the U.S. are formed under the laws of a particular U.S. state - there is no concept of a federal U.S. entity – and the process for forming an entity varies by state. Typically, entities are formed by filing the organizational document (e.g. certificate of formation) applicable to the type of entity selected with the secretary of state of the state where the entity will be organized. The selection of the state where an entity will be organized is an issue that should be discussed with U.S. legal counsel and is based on factors such as where the primary business activities will take place, the initial and recurrent fees and filing or reporting requirements in the state, the applicable state laws on business issues such as liability protection and, depending on industry, the availability of state and local tax incentives. Delaware is a popular choice for state of organization due to its well-developed corporate law and the familiarity and comfort of U.S. investors with Delaware entities.
State Registrations Outside State of Incorporation. An entity that will operate in states outside of its state of organization may also need to register to transact business in these other states, depending on the level of business activity in each state, and will also need to comply with all annual reporting requirements and pay applicable taxes and fees in each state in which it is registered.
Organizational and Governing Documents. When an entity is formed organizational and governing documents should also be prepared that set forth the terms of the governance and operation of an entity, such as bylaws in the case of a corporation and a partnership or operating agreement in the case of partnerships and LLCs. There may be other governing documents that need to be prepared, including, by way of example, management agreements between the U.S. entity and non-U.S. affiliates and shareholders agreements among the shareholders of the entity, if a corporation. The individual business operations for each U.S. entity should be considered in determining the type of organizational and governing documents that will be required.
Employer Identification Number. A U.S. entity that will have employees, file tax returns, or open a U.S. bank account, among other things, is required to obtain an Employer Identification Number (“EIN”) from the United States Internal Revenue Service (“IRS”). An EIN is the number issued by the IRS to identify a business. An EIN can applied for by completion of the IRS’s Form SS-4, Application for Employer Identification Number, which can be submitted online thorough the IRS’s website or faxed to the IRS in accordance with the form’s instructions.
Other Formational and Operating Considerations
Opening a U.S. Bank Account. In order to conduct business in the U.S., a U.S. entity will need to set up a U.S. bank account. To apply for a U.S. bank account an entity will typically need an EIN, a Form W-9, Request for Taxpayer Identification Number and Certification, a Certificate of Good Standing that shows the entity is formed and is in good standing in its state of organization, photo ID for the company representative who is opening the account and proof of business address. Most banks will require new customers to visit the bank in person and present their paperwork in order to open an account and do not permit setting up a bank account online.
Licensing and Permits. Depending on the type of business that will be conducted, certain permits and licenses may be required in order to being operations. Each U.S. entity should consider what permits and licenses will be required at the city, county and state levels where business will be conducted and whether its business is subject to industry-specific regulations and licensing requirements such as obtaining a business license and/or a health permit. Counsel should be consulted in the particular states where operations will occur regarding any licensing requirements.
Employees. If a U.S. entity will hire employees there are a number of regulatory and tax requirements to consider, including, for example, the requirement to pay payroll taxes, the structure of employee compensation packages, employee benefits such as health insurance plans and retirement savings plans and requirements regarding mandatory employee benefits (e.g. the requirement that employers over a certain size must provide health insurance) along with the tax treatment of any employees who are transferred from a country outside the U.S. to the U.S. For U.S. payroll taxes, it is customary for U.S. companies to use a payroll company to process payroll, withhold and remit taxes and prepare the required quarterly and annual payroll tax returns.
Additionally, if a business intends to transfer personnel from countries outside the U.S. to the U.S. to run the new operation, there will be number of immigration issues to address. Also consider that obtaining the required visas to permit a non-U.S. citizen to work in the U.S. can take several months and possibly longer and may not be possible to obtain. U.S. legal counsel that specializes in immigration law should be consulted as soon as possible if a business intends to hire personnel who are non-U.S. citizens.
Accounting. Although there is no requirement in the U.S. that an entity hire an accountant, it is highly advisable to do so, as the accounting and tax laws in the U.S. are complex, subject to change and an entity can face substantial penalties for failure to comply with tax filing obligations in the U.S.
Intellectual Property. Intellectual property rights (e.g. trademarks and patents) obtained outside of the U.S. may not carry over into the U.S. Because of this, the registration and use of intellectual property should be considered well before business operations are expanded to the U.S. This is a specialized area that requires the guidance of U.S. legal counsel with expertise in intellectual property laws.
U.S. Reporting Requirements. There are very specific reporting requirements for U.S. entities that are owned outside the U.S. and failure to comply with these requirements may result in significant penalties. For example, a U.S. corporation must report direct and indirect non-U.S. ownership, as well as transactions with non-U.S. related parties when it files its U.S. federal income tax return. Additionally, a U.S. company that makes certain payments such as interest, dividends, rents and royalties to related or unrelated non-U.S. parties may be required to withhold U.S. income tax and file an annual report of the transactions.
Additional reporting requirements include the requirement to file a Form BE-13 Claim for Exemption for any acquisition, establishment or expansion by a non-U.S. entity in the U.S. when the cost of the transaction is $3,000,000 or less. Also, the U.S. Department of Commerce, Bureau of Economic Affairs requires non-U.S. direct investment in the U.S. to be reported.
Also, the state of an entity’s organization and any other the states in which it is qualified to do business will have tax and other filing implications.
Dentons US has counsel throughout the U.S. with the expertise to assist a non-U.S. investor in setting up initial business operations in the U.S. To obtain additional information on how Dentons US can assist with your U.S. legal needs, please contact Donald A. Hammett, Jr. or Christina Heddesheimer.
The statements made herein represent only the authors’ personal opinions and do not represent the views of Dentons US LLP or any of its clients.
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