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2015 Legal Risk Tune-Up

Ten Keys to Successful Global Entity Formation

Cross-Border M&A, Restructuring, Inversions or Just Want to Establish a Company Abroad. What are the Key Legal/Tax Issues?

Companies with multiple entities established outside of their home countries - or even with a single company abroad - face legal risk and tax issues at the establishment, operation and dissolution/restructuring stages.

A 2014 multi-country entity management assignment handled by David Laverty for a Fortune 50 company led us to summarize ten of the key issues faced by companies with entities abroad, built on our long history of cross-border entity work.

Mid-sized and larger companies with foreign operations that are in the midst of restructuring and sales/purchases are encountering just these sorts of issues.

The increase in M&A activity is partly responsible - in the U.S. middle market, Thomson Reuters reported that 2014's deal value of $315.3 billion was the highest since 2007.

Global entity rationalization is another driver of entity restructuring. As KMPG put it in a 2014 report, Legal Entity Rationalization:

“Companies have shifted into strategic mode from the survival mode that marked recent years during the global economic recession. By aligning the organization’s legal entity structure with business strategy, companies can design a future state that more accurately reflects its business needs.”

Yet, many of these same issues apply to any company establishing even a single presence in another country.

Foundation:  An International Tax Cheat Sheet

Establish in a Low-Tax Country. Know Your Withholding Taxes and Tax Treaties. Reduce Withholding Taxes Through Offshore Holding Companies. Advantages of "Flow-Through" Entities. Multi-Country Asset Carve-Outs

Before we dive in, many cross-border entity issues involve international tax concepts. We recognize that some of our clients and contacts are frustrated when tax professionals rely on jargon and hyper-complexity when speaking about tax treaties, inversions, withholding taxes and permanent establishments. Is there any harm to explaining what all of this means?

As international legal advisers who must make sense of all of this and more to busy business professionals, we put together an international tax cheat sheet. The Cheat Sheet is available to in-house teams upon request: info@internationalcounsel.com.

Don't be embarrassed to ask us for the cheat sheet (in-house counsel, paralegals and other corporate executives are welcome!).


  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).
>> more on tax strategies - listen to your advisers but exercise independent judgment >>

Politics aside, responsible companies need to consider whether their international corporate structures best take advantage of perfectly legal and acceptable tax strategies that respond to the interaction of tax policies across multiple countries. For responsible companies, this is not about hiding assets in tax havens, laundering ill-gotten profits and greedily avoiding taxes.

Nonetheless, stepping back from the details, companies and their boards are faced with difficult judgment calls on how to structure their foreign operations and whether their actions will invite political backlash from employees, regulators and the press even if legal. An important take-away - listen to your advisors but exercise independent judgment based on your company's appetite for risk and stakeholder base.

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.

>> why is this? >>

Some advice may sound risky but is actually sound. In one of our 2008 articles, we noted the advantages of acquiring an Indian company through a Mauritius holding company. US companies may believe that this sounds a little exotic and unnecessary and may prefer a more straightforward holding of an Indian or other foreign company directly by the parent or a US-based special purpose subsidiary.

Part of the reason - if a directly-held Indian company is sold after 1-year as part of a stock sale, a long-term capital gains tax of more than 20% will be imposed on the buyer as a withholding tax (and even more if sold within less than 1 year). The tax will be far less if held through a holding company in a jurisdiction such as Mauritius or Singapore with favorable tax treaties (under the Indo-Mauritius tax treaty, capital gains accruing to a company resident in Mauritius are only taxable in Mauritius, where capital gains tax dividend withholding taxes are 0%, and other taxes and fees are low).

One InternationalCounsel client that did not follow our holding company recommendation out of an expectation that their Indian investment would be held for the long term paid a price only months later when new management were forced to take a discount when that same company was sold to another US-origin buyer faced with a significant holding tax.

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.

>> anti-avoidance update: India >>

For example, the Indian government is invoking anti-avoidance rules that allow it to override tax treaty benefits in the event of "impermissible avoidance arrangements." While effective as of April 1, 2015, India's announcement of these rules at least temporarily caused Singapore to overtake Mauritius as the most favored holding company destination for Indian investment due to Singapore's more conservative anti-avoidance rules.

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.

>> are anti-avoidance rules in China changing this approach? >>

The use of Hong Kong holding companies for Chinese entities had allowed a savings on withholding taxes and also allowed a sale of the Chinese company without Chinese regulatory approval - the Hong Kong holding company itself would be sold, and with no need for Chinese government approvals since Chinese ownership has not changed (still owned by its Hong Kong parent).

Another take-away - be sure that your advisors are following current practices, since Chinese authorities have since adopted their own anti-avoidance rules and will look past the Hong Kong or other holding company structure if the holding company is merely a shell and does not itself have a business purpose beyond tax savings. Just in early December, 2014, the anti-avoidance approach further clarified that Chinese authorities will disallow arrangements (whether through Hong Kong or otherwise) which lower taxable income and lack reasonable business purpose (with the reduction, avoidance or deferral of tax payments as the primary purpose).

The Netherlands - A Holding Company Paradise?

>> tax treaties help make it a favored destination >>

Our projects at times make use of a Netherlands holding company structure, including in 2014. The Netherlands is often used for holding companies, and a favored entity is the Dutch B.V. Many are aware of the Netherlands' excellent and likely unmatched treaty network and the relative lack of anti-avoidance concerns when using the Netherlands. There is a tax exemption on dividends and capital gains for qualifying subsidiaries, almost no substance/business purpose requirement for the holding company and low incorporation costs and annual ongoing costs for a B.V.

  1. 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."
>> which countries rank the highest, where do China, India and Brazil stand, and what about the US? How do they rank for overall "Ease of Doing Business"? >>
For 2014, the top 10 includes Hong Kong and Singapore as well as New Zealand and Canada, and economies scoring less favorably include Mexico (67), Japan (83), China (128), India (158) and Brazil (167). The US? A respectable but less-than-ideal number 46 (the UK is 45).

Note that the World Bank's overall "Ease of Doing Business" ranking is something of a proxy on whether a foreign investor may face restrictions to even entering the economy and does not track the "Starting a Business" ranking as much as may be expected - Korea is number 5 on overall ease of doing business yet 17th for starting a business, the US and UK are back-to-back 7 and 8 on overall ease of doing business, and China jumps to 90 as compared with overall ease in Brazil at 120 and India at 142.  The rankings are found at http://www.doingbusiness.org/rankings.

  • “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."
>> reduced capital and easier formation in the Netherlands >>
For example, the use of Dutch holding companies in our 2014 project was made even more attractive by the elimination as of 2012 of the former minimum capital requirement of €18,000. Also as of July, 2011 the requirement for a Ministry of Justice "certificate of no objection" was eliminated, which had taken days to weeks while the Ministry conducted an investigation into the intentions, financial history and criminal records of those in the company with responsibility for determining policy.
  • 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.

>> take note: new resident director requirements in India, with an April 1 deadline >>

For example, under the Indian Companies Act, 2013 it is now mandatory for a company to have at least 1 resident director (who has resided in India at least 182 days in the prior calendar year), though prior to that it was not required though still practically important to appoint a director resident in India.

Those incorporated after September 2014 must have a resident director in place upon the date of incorporation, and existing companies must appoint a resident director by April 1, 2015 - US and other companies with a subsidiary in India, take note of this requirement.

  1. 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
  1. 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.

  1. 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.
  1. 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.
>> more on handing KYC requests with a cooperative but firm hand >>

If possible, make use of a detail-oriented paralegal who can provide what is necessary to local parties yet have the good judgment to push back or ask for senior support if the requests appear to be overreaching.  We have seen clients resist providing what may be legitimately necessary under local law, but have also seen banks and trust companies go too far into a fishing expedition for all that could conceivably protect themselves.

This is an evolving area of practice and some regulated entities simply do not know what will be needed in their files in case they run up against a money-laundering or terrorist-funding client. Thus, many tend to treat even large publicly-traded clients with the same degree of questioning as the most unknown local trader.

  1. 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.
>> more on setting budgetary ground rules >>
Our recommendation is to take the time to set some ground rules, and even a budget range without a set cap can work wonders in keeping counsel on notice that the tap is not on for unmonitored billings. When entity establishment takes an unexpected turn - whether through changes in corporate structures due to tax reasons, revised M&A deal terms or otherwise - the budgets can be revisited and approved.

The fee issues can be easily put to the side due to time pressures and an understandable pressure to make sure a deal or restructuring gets done and gets done the right way, and it is only after the fact that pencils may be sharpened and in-house counsel subject to criticism for ballooning legal expenses. As deal lawyers know, though, when the transaction is large enough or legal fees are being paid by the other side, the reigns can be quite loose and this is immediately recognized by all lawyers on deck.

  1. 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.

>> more on working with in-house teams >>
A solid internal paralegal can be a great asset in helping to dig-out existing corporate structures and the identity of authorized signatories, and in actually pinning-down signatory availability and helping to be sure that they are available when needed. Internal finance teams may be charged with approving changes in entities and structures and are the other important allies within a corporate client, of course along with in-house counsel who may be overwhelmed with leading transaction negotiations with or without the support of their lead outside transaction counsel.

  1. 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.
  1. 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).
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