Ten Keys to Successful Global Entity Formation

1. Choose the Right Entity/Holding Companies

Corporate form or flow-through tax treatment? What about India, China, the Netherlands and anti-avoidance hurdles?

• Type of entity - corporate form or flow-through tax treatment?  Do not assume that a corporate form is best just because it is familiar and limits liability (other forms of entity can accomplish that), and for more sophisticated investors, do not assume that a “flow-through” entity is automatically preferable. Tax treaties between the holder’s country and the entity country are of course a key to determining the ultimate tax treatment (we say "of course" because now even those of you who read the cheat sheet know this).

For a “flow-through” entity, income is taxed locally on a current basis (it “flows through” to the holders, whether or not distributed) and there may be additional taxes (such as the US “branch profits tax” imposed on holders of US LLCs). Filing obligations may make a flow-through entity even more costly and burdensome than the corporate form (foreign holders of US LLC’s, for example are subject to separate tax filings, unlike foreign holders of US corporations).

As we were reminded in 2014 projects on behalf of Asia-Pacific companies entering the US, we find that foreign holders of US LLC’s, for example, often understand the benefits of avoiding an entity level corporate tax, but may not be aware of the US branch profits tax and the holder’s tax filing obligations. This can lead many back to a corporate form as their best option.

• Offshore holding companies - worth considering and when?  Tax strategies and the use of foreign holding companies have been an unexpectedly popular topic in the general press. Even casual followers of the news have learned that Apple holds several billion abroad that can only be brought back to the US with significant US tax payments, and that corporate "inversions" are being considered by US companies in part since they are at a disadvantage due to US taxation on a worldwide and not a territorial basis (a company with a headquarters in Europe or in virtually all countries outside of the US is taxed on income earned in the territory of incorporation, unlike a US company that is taxed on income earned worldwide).

India - Mauritius, Singapore or Where? The actual investment numbers into India speak volumes:  almost 40% of all foreign direct investment into India form 2000 to mid-2012 came through Mauritius, with only 6% of such investment originating in the US.

Anti-Avoidance Rules.  Anti-avoidance rules are limiting the ability of companies to take advantage of such tax treaty benefits if shell companies without more are utilized.

China - What about that "Traditional" Hong Kong Holding Structure? US and other companies have typically followed a holding company structure when investing in China, holding their Chinese subsidiaries through the popular Hong Kong holding company route.

The Netherlands - A Holding Company Paradise?

2. Take Care in Forming the Entity

Timing and regulatory approval. "Business purpose” in formation documents. Capitalization. Directors and shareholder requirements.

• Timing of Formation and Potential Need for Regulatory Approvals.  Many economies such Hong Kong and Singapore have a quick and simple process for forming companies, and approvals for foreign investment apply in only the narrowest of circumstances. It is important to be aware of potentially longer periods required for incorporation elsewhere (Brazil is one example) and countries that have extensive foreign investment approval systems (the list is thankfully shrinking) may prevent the establishment of a company for a purpose that requires advance approval.

A quick glance at the World Bank's ranking of 189 economies on the basis of the ease of "Starting a Business" offers a general sense of which countries are more time consuming and potentially costly and which are less so. The World Bank methodology "records all procedures officially required, or commonly done in practice, for an entrepreneur to start up and formally operate an industrial or commercial business, as well as the time and cost to complete these procedures and the paid-in minimum capital requirement."

• “Business purpose” in formation documents - not just an afterthought.  US States and an increasing number of other jurisdictions treat the business purpose description in articles of incorporation or equivalent formation documents as an after-thought that can be stated in very broad terms without consequence. Other jurisdictions still require a more carefully-defined business purpose, with actions taken outside of this purpose treated as potentially invalid.

• Capitalization - requirements are often minimal, but formalities call for careful planning.   We have found that many jurisdictions have reduced the minimum capitalization requirements that in years past had been a significant impediment to forming small-scale subsidiaries. Still, capitalization continues to be critical due to a need to estimate subsidiaries' actual capital needs taking into account operational practicalities as well as the board and shareholder approvals that may be required to increase a company’s capital. According to a World Bank 2013 "Doing Business" report, "Ninety-one economies require no paid-in minimum capital, and many others have lowered the requirement."

• Directors and shareholder requirements - what is sufficient?  What actions are required for a valid approval of a change in capitalization, a sale or purchase of another entity, or a dissolution? Is board action sufficient, or even necessary? The answer depends on the company’s formation documents, which will be memorialized in articles of incorporation in many jurisdictions. For example, actions by  an entity in France or Germany may need authorization in situations where authorization may not be necessary for a US company.

We recommend that all companies take into account the practicalities of taking corporate actions and not simply provide for the minimum required directors or simplest possible processes. For example, while an increasing number of countries may allow the appointment of only non-resident directors who need not be local residents, it may be important for practical reasons to appoint a local director with signature authority who can act when needed.

3. Once Formed, Ensure Valid Corporate Actions

Formalities in corporate resolutions. Obtaining required signatures. Electronic signatures

• Corporate resolutions - don’t overlook required formalities. Resolutions will need to be prepared in a valid local form (which may need to be in French or another local language), and signatures may even need to be accompanied by handwritten statements in a local language (France again), be subject to notarizations and even include apostilles or otherwise be subject to processes requiring that notarization is certified by local as well as national authorities.

• Obtaining required signatures, including through powers of attorney. What can be more mundane than obtaining the signatures themselves from authorized signatories?  Yet, when multiple entities may be taking actions on a tight timetable, obtaining physical signatures can be a challenge, particularly in a large organization when subsidiary signatories may require C-suite ink. Travel schedules and the sheer flood of information getting to these signatories may leave narrow windows for obtaining what is needed, and this is especially challenging if detailed local law requirements must be followed pertaining to the numbers of originals, handwritten phrases and notarization/apostilles. Dual signatures may have also been established for onshore as well as offshore signatories, in part to help establish local presences for tax reasons, and the coordination of these multiple signatures must be managed.  

• Electronic signatures and ways to manage these.  The physical signature challenge can be only partially met through electronic signatures, though many companies do not regularly work with electronic signatures and local laws are inconsistent in their requirements and implementation

4. Transfer Funds into the Entity

Bank accounts and requirements

• Signatures and know-your-customer rules.  Funding will need to be made into and out of each entity’s bank account, and newly-formed entities will need to plan in advance for steps required by local banks, including the signature of resolutions and “know-your-customer” banking requirements (see below). While it is natural for legal advisors to focus on the steps needed to complete the formation of an entity up to the point when it can take valid actions, bank account establishment must take place on a parallel path so that signatures are ready to be completed as soon as the entity is established.

What are blocking accounts? Among steps that may not be familiar from a US perspective, some countries, such as Luxembourg, require that a bank account be established in advance of incorporation and the initial capital deposited - in a "blocking account" - with the funds then released or unblocked upon incorporation.

5. Consider Trust Companies

Convenient source of directors and addresses, but potential delays and complications

• There are pros and cons of using local trust companies that can provide directors and addresses and otherwise assist with bank accounts and other local requirements. Such a local presence can relieve a company of a need to tap its internal business teams for signatory requirements, but beware of potentially long lead times for explaining actions to trust company advisors. Trust companies may be increasingly reluctant to accept liability for executing documents unless they are satisfied of the overall background to such actions. This can be especially challenging in jurisdictions with strong "know your customer" requirements and the explanations across multiple time zones may be difficult if complex business and tax reasons underlie the need for certain corporate actions.

6. Beware: "Know-Your-Customer" Requirements

A growing corporate challenge - "prove to us that you are a legitimate company with legitimate business purposes"

• Know-your-customer ("KYC") due diligence is now increasingly required by local counsel and trust companies, as well as banks. A large and growing number of countries are adopting such KYC requirements, and the mini-industry of KYC advisors and their mountains of KYC advisory articles and alerts tend to look at the issue from the perspective of banks and others trying to protect themselves from potentially shady customers and regulators waiting to pounce.

• What about the burden on legitimate companies simply trying to form entities, open accounts and conduct business with some level of efficiency? Beware - the back-and-forth in providing requested corporate organization charts and background as well as details of proposed transactions can delay a transaction and add to cost.

7. Use a Firm Hand with Local Counsel

Questioning and prodding.  Budgets and fee monitoring.

• Don't take local counsel advice as the last word - keep a firm hand in questioning and prodding. A client may have well-established counsel relationships, or new counsel may need to be added in order to handle entity formation or restructuring needs. From the 1980s, to the 1990s and on to the present, we have found that many of the world's leading independent local law firms and their lawyers have generally improved in their practicality and understanding of each others' legal systems. Yet, counsel leading multi-country transactions still need to keep a firm hand to cut through local practices and a local tunnel vision that may view local practices as unique and inflexible.

Counsel who have experience in multiple cross-border transactions over a large number of countries may have seen similar issues being handled in similar ways and can suggest creative solutions that local counsel may not be familiar with or may be reluctant to try without strong prodding. Firm and professional patience and control often trump cutting-edge technical virtuosity when dodging and weaving among differing standards in disparate countries.

• Entity establishment and restructuring can take unexpected directions with added costs, but don't neglect budgets and fee monitoring.  US companies have made progress in setting budgets with counsel, including through a range of alternative fee arrangements. Yet, companies and their in-house and external counsel may let their guards down when it comes to unpredictable cross-border transactions and foreign counsel who may be less accustomed to setting budgets and fee caps.

8. Make Nice with In-House Counsel, Paralegals and Finance/Tax Teams

Support overwhelmed in-house counsel. Who can dig out corporate information and signatory requirements? Approvals through internal finance teams.

In-house teams are often overwhelmed by pressures to set-up, restructure or dissolve the next set of entities as an adjunct to larger M&A, foreign office set-up and tax-driven restructuring transactions, not as the main event. A multi-country quarterback who can take the lead in driving the details for the entities can be a welcome addition to the team, especially one who views him or herself as a true part of the in-house team and can be flexible, accessible and responsive.

9. Look at Software and Technology Tools

Avoid a scramble to identify existing entities - limit delays and cost overruns.

• The bigger and more far-flung the organization, the more challenging it is to even identify entity information that can be "organized" one small step away from a chaotic jumble of file cabinet, PDF and word document bits and pieces. There may be a need to piece together entity history through a series of expensive outreaches to the local counsel who may have helped handle the entity formations.

• Software tools are becoming ever more sophisticated in helping to manage the process (Global Entity Management Software (GEMS) is one example), and we strongly favor making the investment in these tools before a scramble to simply identify existing entities leads to delays and large project cost overruns.

10. Don't Neglect Ongoing Entity Compliance

Periodic local law requirements to limit the risk of fines and penalties

• Those software tools noted above along with capable in-house paralegals can greatly ease the compliance burden, and our firm has also lent-out our resources to help assemble what director/shareholder meetings and local filings are needed. This can help ensure that annual and other periodic requirements are met under local law in order to minimize the risk of fines and penalties (or even involuntary dissolutions and the disappearance of liability protection).