There has been an influx lately of Chinese companies expanding to the United States. Outbound foreign direct investment (FDI) from privately owned enterprises into the US now exceeds US$ 2 billion annually and is growing. This growth is due, in part, to deregulation, such as the change from an approval-based system for outbound FDI to a registration and filing system, subject to certain conditions, since 2014, and the trend of simplifying outbound FDI reporting procedures.
There are many business reasons why a Chinese company would want to expand to the US: among them, to market to US customers, to recruit US engineers and other talent, to attract US investors, to set the stage to become publicly listed in the US. But regardless of the reason, Chinese founders have a number of important corporate and tax decisions to make before implementing a US expansion. A US expansion may have personal implications as well.
In these Frequently Asked Questions, we address key corporate, tax and personal concerns that Chinese companies may wish to consider when pondering an expansion into the US.
FREQUENTLY ASKED QUESTIONS
1. Does my Chinese company need to form an entity in the US? If so, what type?
In almost all cases, to minimize US tax risk for the Chinese company, the Chinese company should form some type of entity in the US. However, it is not wise to form a branch office or limited liability company (LLC). Due to various rules, the branch or LLC could be subject to over a 50 percent tax rate! Instead, it is typically better to form a corporation. A corporation gives the same level of limited liability protection as an LLC would. And although a corporation will have to pay corporate tax on its income, that income can usually be minimized using proper transfer pricing (see #3 below). A corporation may also be subject to other US taxes, for instance, state sales taxes.
In China, local presence is required in most cases. In contrast, in the US, most Chinese companies are not required to form the corporation in the state where they will be operating (e.g., California, New York). Instead, corporations are often formed in Delaware due to its flexible and well-established corporate laws, and then the Delaware corporation qualifies to do business in the applicable state(s).
2. How much does it cost to form a Delaware corporation?
Another advantage of Delaware corporations is that they are fairly inexpensive to form: around US$150 plus legal fees. There is no required minimum capital contribution amount and no deadline to contribute the initial capitalization.
For ongoing annual maintenance in Delaware, the corporation will only be liable for a report fee and franchise tax (US$225 for a corporation having 5,000 shares or less) and a registered agent fee (around US$ 100).
3. How is the relationship between the Chinese company and US corporation governed?
The relationship between the Chinese company and the US corporation must be arm's length – which means that the “transfer pricing” must be appropriate. “Transfer pricing” sets the prices of goods and services exchanged between related companies such as the Chinese company and US corporation. The exact transfer pricing arrangement depends on the functions, assets and risks of each company. Properly structured, transfer pricing can minimize the income tax paid in the US and avoid raising red flags in the eyes of both the US and Chinese tax authorities. To implement appropriate transfer pricing, your company will need an “intercompany agreement,” which is just a contract between the two companies. It is also recommended to draft an annual transfer pricing report to prevent tax penalties.
4. Do I need an intermediate holding company for the US corporation?
One chief concern for Chinese founders is the ability to repatriate cash at a low cost from the US back to China. The US-China Treaty offers a reduced 10 percent withholding tax rate on dividends, interest and royalties, subject to certain conditions, but by interposing an intermediate holding company in the Netherlands or United Kingdom, for example, those rates can be reduced to as low as 0 percent. Please note, though, that your company would need sufficient “substance” in these countries (e.g., registered office, employees, operations) to obtain treaty benefits and reduced withholding tax rates and to avoid deemed dividend distributions from the holding company to the Chinese founders. Your company would also be subject to local taxes in these countries, and therefore a preliminary cost-benefit analysis is recommended.
5. What is the best corporate structure to attract US investors?
If the purpose of the US expansion is to attract US investors, it may be better to “flip” into a US parent corporation. For historical reasons, US investors often prefer to invest in US corporations rather than Chinese companies. In a flip, the Chinese founders exchange their shares in the Chinese company for shares in the new US corporation, and the Chinese company becomes a wholly-owned subsidiary of the US corporation. The Chinese founders may be required to recognize taxable gains even for the cashless share exchange transactions, unless exempted by the Chinese tax authority under a special approval. Please note that a flip comes with increased US tax risk that must be managed carefully.
6. After formation, should my Chinese company transfer its intellectual property (IP) to the US corporation?
It is generally unwise to transfer IP rights (e.g., patents, trademarks, copyrights, software) to a US corporation for US tax reasons. If in the future your company wishes to undertake tax planning, it could be very expensive to then transfer the IP rights out of the US. Furthermore, having your IP rights owned by the US corporation could even reduce the purchase price that you will receive during an M&A exit. Subject to the specific facts and circumstances, it is likely better to keep the IP rights in the hands of the Chinese company and then license them to the US corporation if needed.
7. Can my family and I acquire US permanent residency through a US expansion?
Possibly. There are a number of avenues through which your family and you may acquire US permanent residency (e.g., green cards) by way of a US expansion, subject to other conditions and ongoing assessment of your business.
However, as a US permanent resident, you would be subject to worldwide income taxation, whether your income is derived in or outside of the US, and therefore a thorough understanding of the tax consequences to your family and you is recommended before making a green card application.
In conclusion, with proper planning and advice from legal counsel, your Chinese company can expand to the US. In Part 2, coming soon, we will address the employment and equity compensation concerns for hiring in the US.
A Chinese language version of this article is available here.