Direct distribution
Ownership structures
May a foreign supplier establish its own entity to import and distribute its products in your jurisdiction?
A foreign supplier generally is free to establish a distribution subsidiary in the United States. Doing so can have several benefits, such as:
- serving as a liability shield for the supplier;
- simplifying payments and contract terms with customers (because the transaction and related payments will be between US entities); and
- giving the foreign supplier options as to the form in which it receives income from the US (eg, as dividends instead of product purchases).
Establishing a US subsidiary will have tax, transfer pricing, staffing and other consequences. The foreign supplier should work through these considerations with its accounting team, tax advisers and other advisers.
Federal or state laws in a few specific industries (such as national defence, banking and alcoholic beverages) restrict foreign ownership and may block establishment of a subsidiary. In addition, US embargoes and sanctions could prohibit formation of a subsidiary. The Office of Foreign Assets Control of the US Department of Treasury maintains lists of embargoed countries and blocked individuals and entities.
May a foreign supplier be a partial owner with a local company of the importer of its products?
Yes, generally, a foreign supplier can be the partial owner of its importer or distributor, with exceptions for certain industries and any applicable US embargoes or sanctions.
What types of business entities are best suited for an importer owned by a foreign supplier? How are they formed? What laws govern them?
There are both tax and non-tax considerations in choosing the form of an entity. The basic choice is between a corporation and a limited liability company (LLC). Although various partnership and limited partnership forms are sometimes available, they are not likely to be best suited. At a high level, the most important trade-offs between a corporation and an LLC are these:
- A corporation is taxed at both the corporate level and the shareholder level, whereas an LLC is taxed like a partnership (ie, treated as a pass-through entity, where the LLC’s earnings and losses pass through the LLC to its owners, and each owner’s respective share of earnings or losses is included on the owner’s tax return). If the LLC has only one ‘member’ (equity owner), it may even be disregarded entirely for tax purposes and not have to file tax returns at all. However, for the foreign supplier and other non-US investors, a corporation may still be preferable from a tax perspective. Tax treaties between the US and the foreign supplier’s home country (or the lack thereof) may also affect the decision.
- LLCs are easier to set up and more flexible than corporations in terms of management and governance. The owners enter into an operating agreement or company agreement that defines how the LLC will be managed. The LLC can be member-managed, or it can be run by one or more ‘managers’ who need not be members. The powers of the members and managers are defined by contract in the operating agreement. By comparison, corporations have more legal formalities that must be observed (eg, a corporate charter, by-laws and a board of directors), as well as compliance with regulatory reporting requirements. Compliance with these formalities may involve significant legal costs.
- A corporation is usually a better choice if the business entity will have more than a small number of owners. For LLCs, managing and documenting ownership changes can be unwieldy, and it is more difficult for an LLC to offer equity incentive plans to executives and employees.
Corporations and LLCs are formed under state law by filing organisational documents with the chosen state. The laws of that state will govern the internal affairs of the business entity and the relationships among the owners and the entity. From a state tax perspective, there may be an advantage to forming in one of the six states that do not have a corporate income tax at the state level or one of the seven states that do not have personal income tax at the state level. But as a practical matter, the overall state tax burden may depend more on where the business entity transacts business than on where it is organised.
There are also non-tax considerations to deciding where to organise. The state of Delaware has been the leading choice for many years, not because it lacks corporate income tax (it has one), but because it has an extremely well-developed body of corporate law and special courts with expertise in business entity issues. Delaware is the closest thing in the US to a ‘national’ law of corporations. Nevada is another state that has made an effort to make itself attractive for incorporation. Texas is also friendly for business formation, but its business entity codes are somewhat more parochial.
Another non-tax consideration is where the foreign supplier wishes to establish the US headquarters. The simplest approach is to form the subsidiary in the state where it will be headquartered, although the benefit is minor if the company will operate nationwide. Companies formed in one state often have to register to do business in other states as they go along. If the subsidiary incorporates in Delaware but establishes headquarters in California, for example, the subsidiary would have to register to do business in California as a foreign (non-California) corporation.
Finally, another non-tax consideration is which state law the foreign supplier wishes to govern the contracts of its subsidiary. For a contractual choice of governing law to be enforceable, the subsidiary must have a valid connection to the state chosen, either by incorporation or its principal office. For example, for Texas law to apply, the subsidiary should incorporate there or have its office there, or both.
Restrictions
Does your jurisdiction restrict foreign businesses from operating in the jurisdiction, or limit foreign investment in or ownership of domestic business entities?
Generally, there are no restrictions on where the foreign supplier operates within the US or on ownership of domestic business entities. Restrictions on ownership exist in certain industries and in circumstances where US embargoes or sanctions apply.
The foreign supplier may need to qualify to do business in states where it is doing business. This is a simple registration under which a business entity from outside of the state agrees to be subject to the jurisdiction of the state and appoints an agent for service of legal process in the state. Whether qualification is required depends on a fact-based assessment of whether the company is ‘doing business’ in that state, as that state defines it. The consequences of not qualifying when required to do so are usually not serious, but the company will not have access to the courts of the state until it has qualified.
Equity interests
May the foreign supplier own an equity interest in the local entity that distributes its products?
Yes, generally, a foreign supplier can own an interest in its importer or distributor, with exceptions for certain industries and subject to any applicable US embargoes or sanctions.
Tax considerations
What are the tax considerations for foreign suppliers and for the formation of an importer owned by a foreign supplier? What taxes are applicable to foreign businesses and individuals that operate in your jurisdiction or own interests in local businesses?
US income taxation is a complicated subject involving federal, state and local taxing authorities. The information below is limited to US federal income taxation. Foreign suppliers wishing to do business in the US should consult professional tax advisers. Income tax treaties between the US and the foreign supplier’s home country can affect the preferred structure and the tax burden from US operations.
Foreign businesses and individuals are subject to US federal income tax on income that is deemed to be ‘effectively connected’ with a US trade or business, in the same manner as if they were US persons. A foreign corporation that has effectively connected income (ECI) is also subject to a 30 per cent branch profits tax on after-tax net income that is repatriated from the United States to the foreign home office. If a branch continually reinvests its income to expand the US business, it will not be subject to the branch profits tax until it actually repatriates the US income.
Being ‘engaged in a trade or business’ is not defined in the US Internal Revenue Code or related regulations. However, the supplier will always be deemed to be engaged in US business if employees of the foreign supplier perform services within the United States. Fact-specific revenue rulings by the US Internal Revenue Service and case law provide guidance on when a US trade or business exists in other circumstances. In general, the decisions establish that activity in the United States must be ‘considerable, continuous, and regular’ to constitute a US trade or business. Being engaged in a US trade or business is determined separately for each taxable year.
If the foreign supplier has ECI, it must file a US federal income tax return. The foreign supplier is entitled to deduct effectively connected expenses of the US business from the income reported. If the foreign supplier invests in a US operating business, either directly or through an entity treated as a partnership for US income tax purposes, the supplier itself will still be required to file a US tax return and pay taxes on its share of ECI generated by the operating business.
Generally, all US-sourced income of the foreign supplier (as determined by US tax laws) is considered to be effectively connected with the US trade or business and is subject to US income tax. Accordingly, the foreign supplier must determine whether its income is from a US source or a foreign source for US tax purposes. There are different sourcing rules for different types of income under US tax law. Sales income is generally sourced where legal title passes.
Income tax treaties, where applicable, may raise the threshold of when a foreign company is subject to US tax on business income. For example, income tax treaties may include permanent establishment provisions. These provisions generally specify that a foreign person is not engaged in a US trade or business unless it has a fixed place of business in the US or there is a dependent agent that regularly concludes contracts on its behalf within the US.
Income that is US sourced but is not ECI is treated as ‘fixed or determinable annual or periodic’ income (FDAP). FDAP income includes but is not limited to interest, dividends, rents, royalties and annuities. FDAP income paid to the foreign supplier is subject to 30 per cent US withholding tax. The withholding rate may be reduced by income tax treaties.
Forming a US subsidiary corporation can alleviate some of the federal tax burdens for a foreign supplier if the subsidiary employs the individuals who perform services in the US and holds the investment in US-operating businesses. In particular, the foreign supplier would avoid the branch profits tax and could avoid withholding tax on dividends if the subsidiary does not make distributions to the parent until winding up its affairs. Depending on the foreign supplier’s structure and home country tax rules, it could be beneficial for the foreign supplier to structure the US subsidiary as a US partnership entity that elects to be treated as a corporation for US tax purposes.
Law stated date
Correct as of
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15 March 2021.