Part 3: Expanding Your Business Outside the United States
October 7, 2019
Over the last three months we have presented Parts 1 and 2 in a series on recommended actions for starting to do business internationally. We have covered choosing the type of legal entity based on whether there are restrictions on foreigners owning such entities, whether the country allows that type of entity to engage in the business you desire, and examining the tax consequences of opening the new entity. Our hypothetical Delaware corporation, ABC Co., which makes and sells sporting goods, wants to open an Indonesian subsidiary or to partner with its existing Indonesian supplier in a new joint venture.
Based on the analyses covered in Part 1 and Part 2, ABC has narrowed down their entity choices to either an LLC or a corporation, which receive very similar tax treatment in Indonesia. However, because Indonesia forbids foreigners from owning a majority of shares in a corporation, and ABC wants to own at least the majority of the new company, the corporation form is not desirable. The PMA form of LLC (an LLC entity specifically for foreign investment) will allow a majority or even 100% foreign ownership, so ABC’s best choice for its new company is a PMA.
Direct or Indirect Ownership?
The next question is whether ABC wants to own the PMA (“ABC-Indonesia”) directly through its U.S. headquarters (“ABC-US”) or to create an off-shore company. The major consideration in making this decision is the tax consequences of owning the LLC directly or indirectly through a third country.
In our hypothetical case, ABC does not intend to issue any dividends for at least five years, and instead will re-invest all profits back into the LLC. However, far in the future, ABC may start re-patriating dividends to the US.
If it does, then ABC-US will not pay significant taxes on any dividends or distributions from ABC-Indonesia, since it will not repatriate these funds into the U.S. The tax consequences of ABC’s options are as follows:
|Owner of ABC-Indonesia||Tax|
ABC-US is direct owner, issues no dividends, keeps $$ in Indonesia and re-invests in the business
|0% tax on 0 dividends|
ABC-US is direct owner, repatriates $$ to US
|US-Indonesia dual tax treaty provides 15% tax by Indonesia on dividends, royalties and interest; US income tax/capital gains tax must be paid also.|
ABC-US is indirect owner through offshore vehicle, $$ stay offshore
|Example: UAE-Indonesia dual tax treaty provides for 10% tax on dividends, 5% on royalties and interest; Dubai has a 0% corporate tax rate so if the money is kept in UAE, there are no further taxes.|
ABC’s lawyer advises them to directly own ABC-Indonesia for now, and when the time comes that dividends are paid out and both Indonesian and US taxes must be paid, consider inserting an off-shore holding company in a jurisdiction whose dual tax treaty with Indonesia is more favorable than the USA’s. The off-shore vehicle could be used to make other international investments, especially if they involve foreign investors (who often prefer off-shore holding companies for their own tax reasons).
To Partner, or Not to Partner?
Now that ABC has decided to create a PMA directly owned by ABC-US, the only remaining issue is whether to share ownership of the PMA with ABC’s long-time Indonesian supplier. Weighing the pros and cons might look like this:
|Local contacts in business community|
Giving up portion of profit and control
|Local contacts with government||Danger of partner violating FCPA because bribes are a way of life|
|Knowledge of local business customs, expected salaries and benefits||Local reputation depends heavily on partner’s good behavior and business skills|
|Established relationship of goodwill and trust between the parties||Great temptation for nepotism in hiring (a common and acceptable Indonesian practice)|
|Familiarity with ABC’s business, supply chain||Partner’s lack of initial capital to put in company|
ABC knows that the workers it will hire will all be locals (with the exception of one or two U.S.-expat managers who will get the factory started), and that the company will need local government contacts to obtain all of the necessary building permits and local supplier contacts for building materials, construction services, etc. If the jurisdiction allows LLC partners to create an operating agreement that will allow them to allocate decision-making ability sufficiently to ABC as a majority member, then it could ensure that its vote is necessary for all major decisions and that the local partner would have little power over the company. Then, ABC would be more comfortable offering equity to the local partner in order to motivate it to help drive the company’s success. Because Indonesia allows such bespoke operating agreements, and based on past experience, ABC feels confident in the integrity and reliability of their local supplier, they decide to offer the local partner a 15% interest in the new business.
In developed nations, the incorporation process is straightforward and relatively quick, with a short checklist of documents that must be completed and filed with a governmental authority. However, in many developing countries the incorporation might be complicated, time-consuming, and in some cases, not even computerized. Whatever the situation, it is imperative to hire an excellent local legal counsel to advise on the choice of entity, local taxes, and the company creation process. Alternatively, a US-based international business lawyer (such as those at Shulman Rogers) can supervise the transaction and recommend local counsel he or she has worked with in the past, or use their international contacts to identify a reputable firm in the foreign location.
While it may seem too expensive to hire a U.S.-based lawyer to manage a foreign lawyer, doing so can result in cost savings and efficiencies by ensuring your company’s desired structure and long-term goals and are kept in mind with every step. Having a liaison to the foreign local counsel takes the burden off the company to ensure all of the proper legal and regulatory requirements are considered and met. An American lawyer can spot differences between U.S. law and that of the foreign country, explain these to you, and recommend future actions to keep in compliance. Further, when the target country is in a distant time zone, you will appreciate having someone else making the phone calls in the late evening or early morning that are necessary for international work. Large international transactions often require a company to have local counsel in many locations around the world. I did a deal a few years ago that necessitated my working simultaneously with local counsel in New York, Toronto, the Cayman Islands, the British Virgin Islands, Helsinki, London, Moscow (where I was running the deal), Dubai, Botswana, South Africa, and Australia, requiring telephonic meetings around the clock for six months. Experienced global lawyers are able to take advantage of time differences by ensuring that when people in one time zone are leaving the office, they have provided necessary information to those in different time zones who are just getting to the office, accomplishing and furthering the transaction 24 hours a day.
LOOK FOR OUR NEXT INSTALLMENT: The company is incorporated and capitalized – what now?
The contents of this Alert are for informational purposes only and do not constitute legal advice. If you have any questions about this Alert, please contact the Shulman Rogers attorney with whom you regularly work or contact us here.