This is my second article designed to help UK companies which are considering setting up a USA subsidiary. For the purposes of this article we will assume a UK resident has decided to set up a C Corporation. We will also assume that the subsidiary is not a pure “internet based” business.

The difference between “State of Incorporation” and “Business Location/ State of Operations” is very important and often misunderstood by non US residents.

The best way to explain this difference is;

A company can only have one state of incorporation but can obviously have operations and presence in many states.

A company can also be incorporated in a state (which governs its affairs) but do no business in that state. There are a number of reasons why a company may incorporate in a different state to its operations but, as you will see below, these reasons may benefit few businesses in reality.

Reasons for incorporating in a different state

There are 4 main reasons often quoted:

Reducing Taxation and Fees

There are several forms of taxes and fees which are incurred by USA companies. These include:

These taxes will be addressed in more detail in a later article – the purpose of this article is to identify whether taxes are a compelling reason to incorporate out of state.

Business owners often incorporate in a different state especially when these states promote that they have low company taxation. However, when this is examined more closely the costs often outweigh the benefits. This is generally because the state of incorporation, whilst not applying taxes to out of state income, will levy a franchise tax. The out of state income will then be picked up by the state of operations as taxes are paid in any state where a business has either a physical presence or regularly uses a state’s economy to generate income.

In summary, incorporating your company in one state whilst operating and generating revenue in another always results in taxes and fees being paid in both states. Often this is immaterial, but it is imperative that the financial and administrative impact is quantified prior to incorporation.

Raising Finance

Some businesses may require additional finance/ investment and, as a result, potential investors are likely to require that the company is incorporated in a “business friendly” state. The favoured state is often Delaware which is discussed in more detail below.

Company Law

A company’s internal affairs are governed by the state it is incorporated in. As a result, it could make some sense to incorporate in a State which has strong, modern business laws and strong legal precedents.

Over one million businesses (including Apple & Google), more than 50 percent of publicly traded companies in the USA, are incorporated in Delaware. Considering that the estimated population of Delaware was a mere 967,000 in 2018, why do a huge amount of companies incorporate in Delaware?

The answer is that Delaware has a legal and court system built around business law which makes it extremely easy to incorporate a business – in fact a business can be incorporate in under an hour. In additional the judge led, Delaware Court of Chancery only deals with business cases and with hundreds of years of legal precedent, arguable no other State has the expertise to resolve disputes as quickly. As a result, most US corporate solicitors are familiar with Delaware’s business laws which provides comfort to investors.

Despite the above, incorporating in Delaware does not guarantee protection against legal action being taken against your company in your place of operations – especially when the claimant themselves has no links with Delaware. Additionally the company will always need to follow local state laws (such as employment laws) in the states where it has a presence. As a result there is always a strong case for incorporating in your main state of operation where your legal advisors are more familiar with the local state laws.

Privacy

A small number of states do not require a director or officer to be identified with the company – instead the company may use a registered agent or a law firm to act as a nominee. Many companies take advantage of this as it provides some degree of protection from creditors and fraud. However, there is a high probability that these states are remote from the place of operations and unless privacy is essential, the burden may outweigh the benefit.

Conclusion

Incorporating in a different state to where the company has its main presence should be thought about carefully.

Most of the benefits to be found in states like Delaware only apply to a small amount of companies and from a UK Residents perspective the main reason is likely to be that it requires investment from a third party such as a VC which is comfortable with the established corporate laws in Delaware and its Court of Chancery. In reality, this only really benefits companies that expect to be sued on a regular basis but the investor may ultimately leave the company no other choice.

The administrative burden of incorporating in one state and having a presence in another must also be considered as, if you incorporate in one state, you must register as a “foreign entity” doing business in the state you have physical presence. This means you have to comply with laws, taxes, reporting, administration and appoint registered agents in both states.

In conclusion, unless there are “investment pressures” it is very likely that the best State to incorporate is where the Company has its headquarters or  major operations.

In the next article we will look at business location/ state presence more closely and significant impact this can have on taxation.

Previous articles can be found here.