Tax Benefits for International Companies Setting Up an Entity in Delaware
Setting up a subsidiary or entity in Delaware can bring significant tax advantages to international companies operating in the United States. This article explores the tax benefits and considerations for international corporations (FCs) when subject to US taxation under Delaware's legal framework. Understanding these nuances is crucial for effective tax planning and compliance.
Domestic vs. Foreign Corporations: Understanding the Basics
A corporation formed within the U.S. is considered a Domestic Corporation (DC), while a corporation formed outside the U.S. is a Foreign Corporation (FC). According to Section 7701(a)(4) and Section 7701(a)(5), the status of a corporation affects its tax treatment, particularly when operating in the U.S.
Tax Obligations for a Foreign Corporation (FC)
An FC that operates in the U.S. must file a Form 1120 Foreign Corporation Income Tax Return and pay corporate income tax as established by Section 11b. The standard corporate tax rate is 21%, but penalties and additional taxes may apply.
Branch Profits Tax and Tax Treaties
FCs operating in the U.S. may be subject to the Branch Profits Tax (Branch Profits Act) as outlined in Section 884a. This tax applies when a foreign corporation has an increase in net assets in the U.S. branch, and when there is a decrease in U.S. assets, this could trigger an additional tax. However, FCs may benefit from tax treaties with their home countries to mitigate these issues under Section 884e.
Advantages for 100% Foreign-owned Domestic Corporations (DC)
Delaware allows the formation of a DC owned 100% by a FC. This arrangement provides additional benefits. For example, under the U.S. tax treaty, a 5% tax rate is often applied on dividends paid from the DC to the FC. This favorable tax rate is highly beneficial, but it only applies if the FC's resident owner has a tax treaty with the U.S.
No Dividend Tax in Some Non-US Countries
It's important to note that some non-U.S. countries do not tax dividends. This can be a significant advantage for international companies looking to minimize tax liability. Adding a Delaware entity can streamline operations and reduce overall taxes, without creating additional tax burdens.
US Tax Reform and New Tax Rates
The recent tax reform introduced lower tax rates for certain U.S. corporations, including a reduced 13.13% tax rate for the portion of DC's profits generated from non-U.S. clients under Section 250. However, the reduced rate applies only in specific situations and may involve complex calculations.
Treasury Information Reporting Requirements
A DC must file an annual Treasury Information Report (Form 1023 or 1099) when a nonresident alien (NRA) owns the shares. This report serves as an information reporting requirement only and is subject to a $25,000 penalty for non-filing or incomplete reporting under Section 6038-a-d. An FC ownership also requires Treasury Information Reporting, which incurs a $10,000 penalty for non-filing or incomplete reporting under Section 6038a(b).
Tax Planning Strategies
Effective tax planning for international companies operating through a DC in Delaware should consider establishing an operating contract between the FC and DC. This contract can help streamline tax requirements and reduce tax liabilities. The physical location of the shareholders and operators will play a role in the design and implementation of such a contract.
Conclusion
The strategic use of an entity in Delaware offers significant tax benefits to international companies operating in the U.S. Understanding the legal and tax implications is essential for optimizing the benefits of setting up a subsidiary in Delaware. It is advisable to consult with tax professionals to navigate the complexities and maximize these advantages.