Hey Guys,
In practical terms, unless you become microsoft it probably doesn't matter which state you incorporate in tax-wise. We received advice saying that Delaware is favorable to business in a variety of legal precedents. Also, Delaware runs incorporation as a business, which makes it easy to take care of things online etc..
Somebody mentioned Wyoming as having less paperwork but I have to say I've never felt there was much paperwork with Delaware.
Without anybody physically present in the US you may need to furnish a bunch of docs - not sure how that would work since we always had one permanent US resident in the company.
In our situation we looked at mixed ownership (US and non US) of a business that had worldwide income (mainly from the US).
Here are the implications of the different US incorporation strategies we came up with. Remember LLCs are flow through (i.e. the LLC does not pay taxes, but it's owners) vs. C-corps that are not flow through (the company itself has tax obligations). Foreign residents cannot own an S-corp (a corporation with flow through treatment).
Incorporation scenarios
1. Clean US C-Corp
Pro:
easy to sell company or assets
transparent
stock exit is good and clean
ability to issue stock options
Contra:
Gain on asset sale allocable to U.S. taxed at 35% U.S. federal rate
double taxation for asset sales, for U.S. owner (no such problem for foreign owners although there may be tax in your own country)
If no asset sale but stock sale instead, purchaser will likely want to reduce purchase price (due to loss of tax benefits)
some double taxation for operating profits (some profits from operating income can be offset by bonuses and licensing payments). Double taxation meaning that there is a federal tax on the company and then a tax on any dividends.
U.S. corp subject to tax on worldwide income.
How to handle regular operations:
Use bonuses and pay for services to zero out operating profits. Compensation paid to non-U.S. persons for work performed outside the U.S. is not subject to U.S. tax.
Any dividends paid to non-U.S. shareholders would be subject to U.S. withholding tax - 30% (or less if an applicable treaty applies).
2. US LLC with Individual Owners
Pro:
easy to sell company or assets
transparent
on asset sale, U.S. owners and Foreign entitled to U.S. 15% capital gains rate for most gain. One level of tax only.
for US owners, profits flow to owners as income and charged regular income tax (+ social security and medicare :( ). One level of income tax.
"Profits" interests can be issued tax-free, which can share in future distributions and appreciation. Can be referred to as LLC units - equivalent to shares.
Contra:
inability to issue stock options (but can issue profits interests as above)
If there are operating profits going to Foreign owners, those owners will be treated as US residents for tax purposes and will be liable to pay full income tax on the profits allocable to the U.S. Also, before any profits are distributed to Foreign owners, the LLC will need to pay to the IRS a 35% withholding tax. However, the Foreign owners can file U.S. tax returns and receive a refund to the extent they are entitled to it.
On a sale of assets or LLC units, Foreign owners would be required to pay tax on gain (most at low federal 15% rate)
How we would handle regular operations:
Use bonuses and pay for services to sink zero out operating profits.
3. US LLC with Foreign C-Corp owners (i.e. your Portugese C-corp would own the US LLC)
Pro:
Same as in 2.
Contra:
inability to issue stock options (but can issue profits interests as above)
any tax issues would shift to these C-corps. Each c-corp would owe regular U.S. corporate income tax at a 35% rate on any income allocated to it by the LLC (unless offset by expenses). C corp would also owe a second-level of tax, called the U.S. "branch" profits tax (could be 5% or 15% if C Corp is organized in Cyprus; 30% in BVI or any other country with no tax treaty with U.S. - combined 54.5% rate). But on an exit event and liquidating distribution by the LLC no branch profits tax would have to be paid (this is in comparison with dividends).
LLC still has to withhold profits allocated to Foreign C corps at 35% rate.
How we would handle regular operations:
Same as in 2.
4. US C-Corp that licenses an Offshore company's Technologies
Pro:
U.S. profits offset by royalty payments to offshore entity (this may be hard to do, since profits might fluctuate wildly, and having accompanying fluctuations in royalty payments would be suspect - could base royalty on U.S. revenues). IRS requires that any royalty be based on fair market value rates. To be protected, an outside appraisal would be obtained. A royalty rate of 10% of gross revenues may be in the ballpark, but would have to be confirmed by an appraiser/industry expert. Maybe your business could justify higher rates. But IRS audits this area closely.
Profits of Foreign corp not taxed in U.S. (so long as no services for it are performed in the U.S.) and distributions to non-U.S. owners not taxed in U.S.
Contra:
more legal and credibility problems when exiting
Difficult to sell assets
U.S. has withholding tax on royalties - 30% unless reduced by a tax treaty. Withholding rate for qualifying Cyprus entity - 0%. (For all purposes of qualifying for U.S. treaties, the entities must qualify. For example, if the owners of the Cyprus entity are not Cyprus residents or the entity does not conduct an active business in Cyprus, the Cyprus entity likely would not qualify. In that case, 30% withholding would be required to be paid by the U.S. licensee (if it does not, IRS can impose penalties). (Same for BVI, which does not have a treaty with the U.S.).
Bad tax result for U.S. seller of original technology. Under IRS tax rules, a permanent royalty would be imputed. Each year, the U.S. seller would report income based on the performance of the technology (generally, sales revenues)
If Foreign corp develops and owns the technology, and licenses it to U.S. company in exchange for royalty, U.S. owner should not hold 50% or more of the stock of the Foreign corp. If it does, 50% of the royalty would pass through to the US owner (called subpart F income). If U.S. owner owns 10% or more of the Foreign corp, and the Foreign corp is not in an active business, then distributions to the U.S. owner will carry a painful interest charge (called PFIC income). If profits are distributed each year, this aspect would not be too harmful (so the profits could not stay in the company to avoid taxation beyond the end of the tax year since the U.S. owner would be liable for them). If an active business and U.S. owner owns less than 50%, these passive income rules do not apply. Key is to determine whether Foreign corp would be treated as having passive income.
Both U.S. and Offshore companies have to employ people. The money flowing to the Offshore company is profits only, and will likely not be sufficient to cover significant employee salaries and other expenses; therefore it should be kept to a minimum. However, the Offshore company must employ one or more people to show that it is actually developing that technology for which it is receiving these massive royalties.
How we'd do it:
BVI entity holds IP, U.S. entity operates
C Corp pays royalties to reduce US profits
Hope this helps. Hit me up if you want to discuss further.