Investors or enterprises who seek to establish a cost and resource-efficient legal presence in a U.S. jurisdiction or who aim to ultimately repatriate their profits to a U.S. jurisdiction with the greatest tax efficiency, then Delaware and Nevada offer outstanding characteristics.
By Chet Scheltema
Jul. 25 – Foreign invested enterprises (FIEs) in China face a heavy tax burden. Most encounter a corporate income tax of 25 percent, a business or value-added tax of 3-20 percent (per transaction), and a corporate dividend withholding rate of 10 percent. Confronting the issue of dividend withholding, some have located the parent of the FIE in a jurisdiction with which China has concluded a preferential “double taxation agreement,” thereby seeking to secure the benefits of such treaty’s preferential rates. For instance, Hong Kong, Singapore and Ireland are parties to DTAs with China, so any FIE holding company located in these jurisdictions is eligible for a 5 percent reduction in dividend withholding tax from the normal rate of 10 percent.
So why would any FIE in China not set up a holding company in one of these tax-advantaged jurisdictions?
Enter China’s Circular 601, issued in 2009, and further elaborated by Circular 30 issued in 2012. Circular 601 and Circular 30 are tax avoidance measures designed to ascertain true “beneficial ownership” and stop foreign investors from evading withholding tax by means of shell holding companies strategically located in jurisdictions that are parties to a DTA. To obtain the preferential withholding rate, FIEs must petition the Chinese State Administration of Taxation (SAT) and satisfy the standards of Circular 601 and Circular 30. Ultimate discretion lies with the SAT officers-in-charge, but Circular 601 and Circular 30 make it clear that an empty corporate shell strategically located in a DTA jurisdiction will not qualify. The holding company needs to look and feel like a real company, often judged by considering the size of its staff and operations, otherwise it may be branded a tax avoidance vehicle for which preferential rates are unavailable.
Because of the difficulty of qualifying for the preferential withholding rate, those foreign investors who ultimately wish to repatriate profits to a U.S. jurisdiction may want to reconsider the additional expense of creating and maintaining an offshore holding company and instead look at repatriating directly to a holding company located in a favorable U.S. jurisdiction.
Such U.S. corporate holding companies offer tremendous flexibility. They may be the ultimate destination for monies repatriated from China, they may be a pass-through vehicles (partnerships, S-Corporations, or LLCs) offering substantial tax savings to the ultimate shareholder, or they may serve other purposes in the investor’s broader financial strategy. Additionally, for U.S. non-profits needing to establish a for-profit corporate holding company to hold their China entity (wholly foreign-owned enterprise or representative office), establishing a holding company in a U.S. jurisdiction may also be a cost-efficient and resource-efficient option.
Deciding ultimately which state to locate a U.S. corporate holding company is a complex process, and many practical business matters should be considered, but several jurisdictions warrant consideration, including Delaware and Nevada (with Wyoming earning an honorable mention).
Delaware Holding Companies
Delaware has long been considered a corporate-friendly jurisdiction that has attracted some of the largest and most prestigious corporations in the world. By some estimates, more than half of the corporations listed on the New York Stock Exchange are Delaware corporations. One of the reasons is that Delaware corporate law is generally regarded among the world’s most sophisticated, comprehensive, and corporate-friendly, with a 215-year record of public case law for thorough scrutiny by corporate lawyers.
Certainly, Delaware law would be every bit as friendly to corporate interest as would Hong Kong, Singapore, or Irish law. In addition to this impressive record of jurisprudence and the prestige of the Delaware name, the jurisdiction also offers numerous practical benefits for incorporation.
The cost is as low as US$89 and one-hour incorporation is available for US$1,000. There is no minimum required capital, nor is a bank account necessary, and there are no state income taxes or turnover taxes for Delaware corporations that do not transact business in the state. Where no business is conducted in-state, a local business license is not even required. The minimum annual filing fee is US$125.
Furthermore, no physical office is required, although a registered agent would need to be identified, which can be hired by a commercial services provider. Delaware is attractive to foreigners as well because corporate shareholders, directors, and even officers needn’t reside in the state nor do they need to be a resident or citizen of the United States. Board and shareholder resolutions may be made in writing from any location in the world without the need to travel to Delaware or to hold face-to-face meetings.
Nevada Holding Companies
Another popular jurisdiction for holding companies is Nevada. As a sparsely populated desert state with few reasons to draw national businesses to incorporate, the Nevada legislature has steadily worked to build a corporate-friendly legal and regulatory framework to attract corporations.
Like Delaware, incorporation fees are low – as little as US$75 and about US$500 for each US$1 million of authorized shares. One-hour express incorporation is also available. There is no minimum capital requirement, no need to open a bank account, and a physical address is not required. As might be expected, a registered agent needs to be identified and can be secured by means of a commercial services provider.
One step ahead of Delaware, there is no state income tax whatsoever, even if business is conducted within Nevada. However, a business license is required and annual renewal cost is US$200. Like Delaware, Nevada has also worked to develop a corporate-friendly body of law; the limited liability of the corporate structure has been steadfastly guarded, reportedly to the extent that there has been no case in which the “corporate veil” has been “pierced” for reasons other than fraud.
Not to be outdone by Delaware, Nevada also offers unusually attractive privacy protection. Shareholder identity need not be disclosed, and “bearer shares” are available, which are nameless shares that are deemed to be owned by the person who holds them. Nevada has also not signed an information-sharing agreement with the U.S. Internal Revenue Service (IRS), unlike every other state in the Union except Texas. So, in theory, the IRS will have greater difficulty monitoring the financials of a Nevada corporation.
Nevada’s efforts to create a corporate haven have been effective to the extent that it has been reported by the New York Times that Apple’s global asset management headquarters have been located in Reno, from which Apple reportedly manages a large portfolio of offshore investments.
However, despite Nevada’s impressive accomplishments as a corporate haven, the recent financial crisis and related collapse of the Nevada real estate market (particularly in Las Vegas) lead one to wonder whether Nevada’s revenues will be adversely effected to the extent that it may be forced to reconsider its corporate-friendly taxation policies.
In contrast to Delaware and Nevada, consider the jurisdictions of California and New York, two of the largest economies in the Union. Although the incorporation fees in both California and New York are low at about US$100, corporate income tax is nearly 9 percent in California (with a minimum annual tax and filing fee of US$825) and about 7 percent in New York, although it should be noted that New York utilizes a somewhat complex multi-method process for calculating minimum taxes and imposes the highest result of the several methods utilized.
For any potential China investor considering a Delaware or Nevada corporate parent, it should be noted that the minimum incorporation requirements of each of these jurisdictions, while sufficient to complete incorporation therein, may not satisfy the requirements of the Chinese Administration of Industry and Commerce (AIC) necessary to establish the subsidiary FIE. By way of example, although a business address and bank account are not required to establish a Delaware or Nevada corporation, the Chinese AIC will require evidence that the Delaware or Nevada corporate parent has both, including evidence of capital sufficient to demonstrate the financial stability of the corporate parent and notarized evidence of a physical office location. And also by way of example, although a business address outside the state of incorporation should be acceptable to the Chinese AIC (after all, such a practice is common for many publicly traded multi-nationals headquartered in NYC but incorporated in Delaware), expectations and requirements may vary among the various local bureaus of the AIC.
Despite the absence of state income taxes in both Delaware and Nevada, one can hardly expect to incorporate in the United States and escape the clutches of the U.S. Internal Revenue Service. Any corporation established in a U.S. jurisdiction will certainly be subject to federal taxation, but the point is that those investors or enterprises who seek to establish a cost and resource-efficient legal presence in a U.S. jurisdiction or who aim to ultimately repatriate their profits to a U.S. jurisdiction with the greatest tax efficiency, then Delaware and Nevada offer outstanding characteristics.
And as with the corporate resident of any other U.S. jurisdiction, those of Delaware and Nevada will find available the same federal tools for increasing tax efficiencies. For instance, the availability of pass-through taxation treatment is found in Delaware and Nevada S-corporations, partnerships, and limited liability companies (LLCs) as it is in the same structures found in most other U.S. jurisdictions (the specialized U.S. entity called an LLC should not be confused with the general term “limited liability corporation” used to describe Chinese FIEs such as WFOEs and JVs). Likewise, the qualified dividend rates currently available to U.S. corporate shareholders (set to expire at the end of 2012) would also be available to Delaware and Nevada corporate shareholders without distinction.
In conclusion, with the advent and enforcement of Chinese Tax Circular 601 and Circular 30, offshore holding company jurisdictions traditionally utilized by American corporations to seek greater tax efficiency may have lost some of their attractiveness. For those investors or enterprises, including non-profits, seeking cost and resource-efficient alternatives, U.S. jurisdictions like Delaware and Nevada may meet their needs.
Chet Scheltema is an American business lawyer based in Dezan Shira & Associates’ Beijing office. He assists U.S. companies to establish operations in China.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
For further details or to contact the firm, please email firstname.lastname@example.org, visit www.dezshira.com, or download the company brochure.
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