Even as venture capital markets expand around the world and forge new hubs for business, the unique allure of the US remains constant. The US boasts a vast and affluent base of consumers, robust supply chains and infrastructure, as well as a wide diversity of markets. At some point most businesses will think about US expansion, but the sheer scale and myriad of regulatory hurdles can be daunting. It is crucial to think ahead and ask the right questions before you take that leap.
From setting up a subsidiary, to choosing a location and planning a multi-jurisdictional structure,there are a number of choices to be made, all of which may have an impact on tax and compliance obligations. Complicating matters is the fact that you need to familiarize yourself with not just one set of US regulations, but an additional fifty for each of the states, which operate in many ways as their own individual nation when it comes to compliance, practices, and incentives.
The ideal strategy for one business may not be the same as for another and will depend on the specific nature of the business as well as its ambitions for future expansion. Despite this, there are some fundamental questions that all businesses should consider.
Do I need to set up a US entity if I am doing business in the US?
The first question that needs resolving. You have already set up a company outside the US, it is trading and successful and you now want to expand that business to the US. Can you continue to trade through your non-US entity and service US customers, or should you set up a US entity? The answer to this question will depend on what exactly your business is doing and how it goes about performing this activity.
There are many non-tax considerations here. In general, US persons and businesses will prefer to contract with a US legal entity. This may be for liability purposes and the guarantee of recourse under the US legal system, if needed. It may also be for reasons of familiarity, greater understanding of how US legal entities work and how US regulations apply. Depending on your line of work, a US legal entity may even be required, either as a result of regulation or client/partner policy.
Similarly, if your business requires a US physical presence, having a US legal entity with a US payroll can make it much easier to hire and have access to labor and capital. Some states may even offer incentives to businesses which operate through a local entity.
From a tax perspective, the main consideration is not to create unnecessary compliance obligations. Depending on how your business operates, a non-US entity may not have a US tax requirement even when selling to US customers (we will discuss potential reporting requirements in further detail later). If this is the case, then there may not be a reason to set up a US legal entity from a US tax perspective. Of course, you will still want to consider the non-tax considerations noted above.
On the other hand, if your non-US entity is likely to be subject to US tax and reporting, it may be beneficial to set up a US entity. The US tax filings for a US domestic entity are generally more straightforward than those for non-US entities (who need US tax filings) and while the Federal corporate tax rate is 21% for both US and non-US companies, non-US companies may also need to consider additional withholding and branch profits taxes. Setting up a US entity in this situation also has the benefit of limiting US exposure to just the US entity, without bringing your global business into the US tax net.
The other crucial consideration here is state and local tax. Depending on the state, you can have situations where a US entity brings further state compliance requirements that would not exist for a non-US entity. In some limited cases, the reverse may also be true (more on that later).
What type of US entity should I set up?
Once you have made the decision to set up a US legal entity, the next logical question is what type of entity to set up. This is the fundamental question from a tax perspective, as different types of entities are taxed differently under US law. This will also impact how money is repatriated from the US business.
Broadly speaking, for US tax purposes entities can be divided into two groups: those taxable as associations and those that are tax-transparent, which are instead taxable at the investor level. The three main entity types that are relevant for US expansion purposes are the C-corporation, limited liability company, and partnership.
A C-corporation is an example of an entity taxable as an association. The liability in a C-corporation is limited by shares and it is itself a taxable person subject to the 21% Federal corporate tax rate, as well as potential state corporate taxes. Investors are generally taxable only when income is distributed to them in the form of a dividend. The term C-corporation typically refers to an Inc, which is considered functionally equivalent to a UK Limited company for example.
A partnership, by contrast, is an example of a tax-transparent entity. A partnership may have a US tax return filing requirement, but it is not itself subject to tax on its income. Instead, the investor in a partnership is taxable on the partnership income immediately, even without a formal distribution having been made.
Then there is the limited liability company, or LLC. This may sound similar to a UK limited company, but its tax treatment in the US is quite different. This is what is known as a hybrid entity. An LLC is generally considered to be a tax-transparent entity under US law. If it has more than one member, then it is treated as equivalent to a partnership. If it has only one member then it is disregarded completely and included in the income of its owner for tax purposes. However, an LLC can also elect to be treated for US tax purposes as equivalent to a C-corporation instead. This must be opted into. The reasons for choosing an LLC over one of the other forms of entity are typically non-tax related.
An LLC is generally not recommended for US expansion purposes. This is because, while the entity is tax-transparent by default under US law, it is often treated as a corporate entity outside the US. This can result in some very complex timing issues where income is considered taxable in the US before it is considered taxable for local tax purposes and, in the worst cases, double taxation.
So which entity is best? From a tax perspective this depends on when and where you want income to be taxable: at the entity level or the investor level.
Whichever form of entity you decide upon, you will also want to consider how you go about funding the business. Money can generally be contributed into a business without difficulty, but you will need to be careful as to whether you do so through equity or debt financing, as the definitions and distinction between the two may differ under US tax law compared to local law. Just because you “loan” money to the business under local law doesn’t mean the IRS will view it the same way. That difference between debt and equity can have meaningful tax consequences.
Where in the US should I set up my business?
Choosing where to set up an entity in the US is a big decision that can have material ramifications. In the UK, there are reasons why you may want to set up a business in Liverpool or London, but ultimately both will operate under broadly the same set of laws and compliance requirements. In the US this is not the case. Each of the fifty states will have its own set of rules and they can differ quite drastically from one another.
For the most part, the answer to this question will not depend on tax considerations. Depending on your business, you may want to have a physical presence in a particular state. This could be to access a specific pool of expertise, the cost base, your customer base, transportation links, access to universities and partnerships with other key industry players. It might be for the reasons of prestige, with certain locations closely identified with specific industries and businesses. Or perhaps it is because one state is offering generous incentives to bring your business into their jurisdiction. In general, these are the factors that will primarily determine where you establish your business in the US.
From a tax perspective, the main consideration here is not to create unnecessary additional tax or reporting requirements. Each state will have its own threshold as to when a business has a tax or filing requirement in that state. Many states require there to be income generated from some physical presence or activity in the state, but some may obligate any entity formed within the state regardless of its activity. Some states may require a filing as a result of income generated in the state even if there is no physical or legal presence in the state at all. A few states have no corporate tax.
Invariably you will have heard people mention Delaware as a state where businesses like to set up legal entities. There are many non-tax reasons why Delaware is an attractive state for businesses and with a Delaware entity you can do business anywhere in the US, subject to local laws. From a tax perspective a Delaware entity has the benefit that it does not subject a company to corporate tax or filing unless the company has an actual business activity physically in the state. This means that a business operating in another state can safely incorporate in Delaware without creating additional unnecessary tax requirements.
In general, it is a good idea to consider incorporating in a state where you expect to have physical presence, since it is likely that presence will already have created a tax and filing requirement. If you incorporate in a state where you do not expect to have any otherwise taxable physical presence, then you may want to choose a state that does not impose a requirement on businesses formed but not physically present in the state.
How should I structure my business?
Should you decide to go the route of setting up a US entity, at some point you will need to consider what exactly its relationship should be with your non-US business. Should you set up a parent-subsidiary structure? If so, which entity should be parent?
As with the other questions, there will be non-tax considerations to take into account. Customers, partners and other involved parties may prefer to contract with a US-owned business. If you are a start-up company, some accelerators will require your business to structure with a US parent company. From a tax perspective, the key point to have in mind is that income ultimately flows up the corporate structure at some point. Thus having a parent company in a higher-tax jurisdiction may result in more tax overall. It’s important to note that the US often has Corporation tax rates higher than in many other countries in the world.
You will also need to consider how to allocate income between the entities. Will all income from US activity be allocated and taxed at the US entity, or allocated to the non-US company with a service fee paid to the US?
These types of questions are exceptionally nuanced and will vary considerably based on the specific details of the business, including the nature of the income generating activity, the extent of US physical presence, as well as the specific state(s) and countries involved.
What tax and compliance obligations might I have?
Ultimately, the decisions made thus far will determine the precise compliance obligations of your business. The main consideration for US expansion at this stage of your decision process is corporate tax. This requirement differs for US and non-US entities.
A US entity generally needs to file a Federal US tax return every year regardless of its activity. For a C-corporation this will be Form 1120. As noted above, state corporate or franchise tax requirements may also exist depending on whether the threshold for a particular state has been crossed.
A US entity owned by non-US persons should also consider whether Form 5472 is required. This is an informational return intended to report on certain related party transactions. Failure to file this form when required can result in a flat $25,000 penalty and so is essential to consider.
If you decide to conduct your business in the US through a non-US entity, the rules are more complex. A non-US entity generally has a US tax requirement when it is generating income that is effectively connected to a US trade or business (ECI). This term is based on facts and circumstances, but generally is taken to mean income relating to activities physically performed in the US, such as services, sale of goods manufactured in the US, or sale of any goods where legal title passes in the US. It generally does not include direct sale to US customers of goods manufactured outside the US or services to US customers performed remotely from outside the US.
An additional consideration for non-US businesses is the application of double taxation treaties. Double taxation treaties between the US Government and other non-US governments generally ensure that income is not taxable in both countries and sets out guidance for determining who has the right of taxation. In the context of US expansion, this may allow non-US businesses to be exempt from otherwise US taxable income, provided they meet necessary criteria.
These criteria will vary by country and by treaty, but typically refer to the concept of “Permanent Establishment”. This term essentially refers to a specified threshold of physical presence that is required in order for income to be taxable in that country as opposed to the company’s home country. The specifics of the term will also vary by treaty, but usually require some fixed place of business such as an office or facility (including a client site) from which work is regularly performed. It may also be taken to include certain third parties known as “dependent agents” who act in such a way as to be deemed equivalent to an employee of the company, for example by binding the company in contracts during the regular course of business.
These determinations are all based on facts and circumstances and will depend on the specific details of a case.
Completely separate from corporate taxation is sales tax. Unlike corporate tax, which exists at both a Federal and state level, often at the same time, sales tax is solely a state and local level tax. Sales tax operates similarly to UK or European VAT in that it is not a tax on the business itself, but rather on the end customer that is collected at sale and remitted to the local tax authority.
The rules for when and how sales tax applies can be complex and vary both by state and by the specific activity of the business. Historically, it has been a requirement that a business needs some form of physical presence to meet the threshold (known as “nexus”), however this all changed with the landmark South Dakota v. Wayfair Inc. ruling of 2018 which allowed states to impose sales tax on out-of-state businesses. Since then, most states have switched to an “economic nexus” threshold which is based on the number of sales and the value of sales in a particular state. Each state will have their own specific thresholds that need to be considered.
Finally, when it comes time to bring money out of the US business, you will need to consider the potential tax and reporting requirements that this involves. A dividend payment from a US corporation to a non-US recipient is a potentially withholdable payment. By default, this can result in a 30% tax rate and necessitate filings on Forms 1042 and 1042-S, however this can be mitigated through application of a double taxation treaty.
What else do I need to consider?
US expansion is a significant undertaking. Not just for the business itself, but for the people involved. Any founders, employees or other personnel who relocate to the US or work there, even on a temporary basis, will need to consider the potential implications for the business as well as themselves personally. The US taxes on worldwide income for those who are considered ‘US Persons’, this is a unique position in the world. See our post on What is a US Person here.
Non-US persons who spend more than a certain number of days present in the US for any reason, whether or not they have a visa, or are a tourist may well have a US tax filing obligation, this is called the Substantial Presence Test, see here on the IRS website. Similarly, non-US persons who own an interest in a US entity will need to consider whether they have any US or local tax implications as a result of that ownership.
Any US expansion project that results in the formation of a new US entity will need to consider how intercompany transactions are carried out. Transfer pricing regulations may apply to sales or services between related entities and it is important to ensure that businesses comply with such regulations.
The US continues to offer great opportunities for growing businesses, but equally poses a unique set of challenges. In such a competitive landscape, it is important to prepare sufficiently. If you plan ahead and use advisors wisely, it doesn’t have to be expensive or daunting. After all, you only get one chance to make a first impression.
For further reading, please see our 10 Steps to US Expansion here.
If you would like to learn more or speak to us about the information above, please get in contact via our contact us page.