While setting up a corporation or a limited liability company (LLC) in Delaware or any other U.S. state is straightforward, fast, and relatively inexpensive, U.S. companies should be aware that establishing a registered presence (subsidiary, branch, representative office) abroad may, depending on the jurisdiction, be burdensome, time consuming, document-intensive, and costly. This article focuses on common issues that U.S. companies encounter when establishing a registered presence abroad.
The first step is to determine the right entity type to meet your business and tax objectives. In most jurisdictions, four types of vehicles are available: (i) corporation, (ii) LLC, (iii) branch, and (iv) representative office. Generally speaking, the main differences are as follows:
Determining the business purpose of a U.S. company is simple because most states accept a catch-all description such as “to engage in any lawful act or activity.” In many foreign jurisdictions, however, the business purpose of the entity has to be described with specificity (e.g., in Argentina, China, India, Indonesia, Japan, Malaysia, Peru, Poland, Singapore, Turkey, and Venezuela—just to name a few).
Also, if a new entity is formed as part of a larger transaction such as an acquisition or a spin-off during which the main (initial) purpose of the new company is to acquire assets, special rules may apply to the incorporation process. In Switzerland, for example, if a GmbH is formed for the purpose of acquiring assets, its articles of association must generally disclose (i) the assets which will be acquired soon after the incorporation; (ii) the name of the seller; and (iii) the consideration to be paid by the company (unless the assets are “insignificant”), which can be practically difficult because some of that information may not be available at the time of incorporation.
Most foreign jurisdictions have specific requirements governing corporate names. In China, for instance, only the Chinese name (and not the English name) of a wholly foreign-owned enterprise (WFOE) will be registered, and it must contain the trade name (e.g., “ABC”), a geographic descriptor (typically the city where the WFOE is established, e.g., “Shanghai”), an industry descriptor (e.g., “Business Consulting”), and the type of the company (e.g., Ltd.). If the WFOE uses the word “China” in its name, it will typically be required to have a much higher minimum capital (of RMB 50 million, roughly USD 8 million). In Indonesia, a foreign-invested limited liability company must use the designator “PT” (“Perusahaan Terbatas,” limited liability) in the beginning of its name.
The use of continent, country, or certain industry names may be restricted or it may trigger additional capital requirements. In Russia, the use of “Russia,” “Russian Federation,” and other country names in the corporate name is generally prohibited. In Turkey, the use of the words “Turkey” or “Turk” in the trade name requires a Council of Ministers' decision from the Turkish Parliament, which could take several months to obtain and which will generally be issued only for significant investments in Turkey. The use of the word “Asia” in a Private Limited company in India triggers a minimum capital requirement of INR 5 million (approx. USD 95,000) as opposed to the standard INR 100,000 (approx. USD 1,900). In Malaysia, the use of the term “Laboratory” is generally prohibited and the word “Pharmaceuticals” can be used only if at least one of the incorporators is a registered pharmacist.
Multiple (usually three) alternate names should be determined and their availability should be checked, either because it may be required or so as to provide the local registrar with fallback options in case the preferred name choice is rejected. The meaning of any name chosen should be verified in the local jurisdiction to assure that it is not offensive or otherwise potentially detrimental to the business operations.
Many jurisdictions have specific requirements pertaining to the number of shareholders, allocation of ownership interests, and special qualifications of shareholders. For example, Argentina requires two shareholders for a Srl and a SA (the minority shareholder of a SA must hold a minimum of 10 percent of the capital); foreign corporate shareholders must first register with the Public Registry of Commerce so as to be able to act in a shareholder capacity and, in order to be so registered, they must (i) show that they have significant economic business activities outside of Argentina (e.g., foreign assets or ownership of other foreign entities), and (ii) generally not be restricted from pursuing their business activities in their places of incorporation (which typically eliminates offshore entities incorporated in Bermuda or the Cayman Islands from acting as shareholders of Argentine companies). In Russia and some other Eastern European jurisdictions, a local subsidiary cannot have a sole shareholder who, in turn, also has only one shareholder (prohibition of the “1-1-1 structure”), so that a second shareholder will be needed to incorporate a Russian LLC. In Thailand, an LLC must have at least three shareholders at all times.
Foreign jurisdictions may or may not recognize the U.S.-style “director and officer” concept. In a German, Austrian, or Swiss GmbH, for example, there is no “board of directors” and the company is managed by one or more managing directors (who can, from a U.S. point of view, be considered “officers” because they perform functions similar to those of a President or CEO of a U.S. company) with the main body of the GmbH being the quotaholders' meeting.
Many foreign jurisdictions have specific requirements regarding the number of directors/officers to be appointed and their residency or nationality. In addition, some jurisdictions impose requirements for directors/officers to be registered with local tax or administrative authorities, which can be a burdensome and lengthy process. Some examples:
In addition, some jurisdictions require the appointment of other personnel (e.g., statutory auditor, company secretary, or public officer). For instance, in Australia, a resident public officer must be appointed within three months after an Australian Pty Ltd company commences its business; a Hong Kong Limited must appoint a resident company secretary.
If compliance with certain local registration or other requirements could jeopardize the incorporation timeline, then a possible workaround is to appoint local residents or citizens as directors or officers, at least on a temporary basis (at the risk that these individuals may either be difficult to get rid of later or may ask for compensation for their services).
Capitalization requirements for a foreign entity vary significantly among the jurisdictions. The minimum capital necessary to form an entity may be prescribed as a specific amount (this is the case in most European jurisdictions), in terms of operating costs needed going forward (e.g., in China and Vietnam), or may be tied to a “reasonableness” standard or not be specified at all, in which cases the amount is often determined based on practical experience (e.g., in Brazil, Chile, Colombia).
There may also be deadlines by which the registered capital of a foreign company must be paid in (e.g., in China the registered capital of a WFOE incorporated in Beijing may be contributed in one lump sum within six months of the issuance of the WFOE's business license, or in installments with no less than 15 percent to be paid in within 90 days and the remainder to be paid in within two years of the issuance of the WFOE's business license).
It is important to determine at the outset of the incorporation process what, if any, requirements the local jurisdiction has established regarding the “registered address” and whether these are pre- or post-incorporation requirements. If they are pre-incorporation requirements, their completion may lead to a delay in establishing the foreign entity.
For example, China, Dubai, Greece, Poland, Russia, and Vietnam require some type of real estate document (typically a lease agreement or, in the case of Vietnam, a memorandum of understanding between the landlord and the shareholder of the Vietnamese subsidiary) to be provided during the pre-incorporation phase, and without having such document in place the foreign entity cannot be incorporated. In Russia, the registered address of an LLC must be included in its constitutional documents and in the statutory application for the state registration; in order to secure the address, it may be necessary to negotiate a lease agreement with a landlord who must then issue a guarantee letter to show that the landlord will indeed lease the premises to the new company upon its state registration. In addition, in some jurisdictions (e.g., China), ancillary documents such as building ownership or land use rights certificates may have to be provided during the pre-incorporation process. In the case of a Dubai branch, a lease agreement is required (a sublease agreement is generally not acceptable) which must be valid for at least 12 months, the premises must be approved by the local authorities as being suitable for the activities to be carried out, and the office space must be sufficient for the number of employees to be employed.
When setting up a foreign entity, branch, or RO there may be steps that are particularly time consuming. These “time bandits” should be dealt with as soon as practically feasible so as to avoid time delays.
Also, obtaining FBI clearance certificates that are required in some European jurisdictions (e.g., in the Czech Republic and in France) in connection with the appointment of U.S. individuals as local directors may take several months and ordering them should be frontloaded.
Depending on the jurisdiction, the point in time at which the foreign entity may enter into contracts or otherwise engage in business operations may vary significantly. In some jurisdictions (most civil law jurisdictions, e.g., Germany), a subsidiary can validly conclude contracts after the notarial deed of establishment has been executed (but before the entity has been registered in the local commercial register), provided that it indicates that it is still “in formation.” In other jurisdictions, a subsidiary may not engage in business operations until it has actually been incorporated (e.g., a Malaysian subsidiary should not commence business until the Certificate of Incorporation has been issued) and still other jurisdictions even require that the post-incorporation process be completed before the entity is considered to be fully operational (e.g., China).
Even after a foreign entity has been incorporated, the establishment process is typically not over yet. Rather, in many jurisdictions the incorporated entity now has to go through the post-incorporation phase which can vary significantly in scope and duration (e.g., in China, the post-registration phase for a WFOE typically lasts two to three months, whereas it usually takes two weeks for a New Zealand Limited).
Post-incorporation action items may include the application for (additional) licenses, obtaining tax, payroll and customs ID numbers, registering for VAT or GST, opening a permanent bank account (e.g., for a Russian LLC), or obtaining corporate seals and chops.
Proper planning is one of the keys to accomplishing a smooth and timely entity formation abroad. Familiarizing oneself with the corporate formation requirements and spotting time consuming issues early on is only one piece of the puzzle. “Tax” and “Employment” are usually the other big pieces which any company should carefully consider prior to starting the “going abroad” process.
Irina Shestakova and Daniel Robyn are Partners at Baker & McKenzie LLP, San Francisco. They are members of the firm's International Commercial Practice Group and lead the Foreign Direct Investment sub-group.
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