by Ethan Stone, Stone Business Law
I am currently a citizen of India, and I live in in India. However, I’d like to incorporate my new startup in US. How do I go about this?
First, a quick but important clarification: I’m not your lawyer and this answer doesn’t establish a lawyer-client relationship. I’m giving a generic answer to a generic question to educate the users of this site. The information below is general in nature and should not be understood as a substitute for personal legal advice.
Your question says that you want to “incorporate” in the U.S., but I’ll briefly discuss both corporations and limited liability companies (LLCs), on the assumption that you haven’t thought through which type of entity you want to use.
The Simple Answer
The quick and simple answer is that, your foreign citizenship and residency won’t affect the process of incorporating a startup in the U.S. You do it the same way you’d do it if you were a U.S. citizen and resident:
Depending on who is involved and whether anyone is investing, you might have some securities filings, too. None of this is incredibly complex, but there are lots of ways to mess up, some of which have very bad consequences. So it’s best not to do it as a DIY project. Find a lawyer and pay for a corporate filing service to handle the filings for you (again, CT Corp. and CSC are the best known but there are many others).
Although there’s no reason you can’t form a corporation in the U.S. as a foreign resident, doing so can raise additional complications. I’ll discuss two major ones: U.S. regulations that may apply to activity abroad if the entity is formed in the U.S. and taxation. These are complex areas of law. I’m going to give a general description of the issues involved, but you’ll definitely need to retain competent tax counsel involved to help you think through the tax implications of your specific situation and plans. If specific U.S. regulations seem like they might be an issue, you should also hire a lawyer who specializes in them to help you think things through.
When you form a U.S. entity, you create a legal person in the U.S. That means that some activities abroad may come under U.S. regulations that wouldn’t apply if no U.S. person were involved. I’ll discuss a couple of areas where this is likely to raise issues – the Foreign Corrupt Practices Act and U.S. “export” regulations – but there are many more. So it’s probably worth having a U.S. lawyer (or an Indian lawyer familiar with U.S. laws) review your business plans, especially planned activities outside the U.S., to make sure you know what you’re getting into.
Foreign Corrupt Practices Act (FCPA)
The federal Foreign Corrupt Practices Act basically prohibits U.S. persons from bribing foreign officials, political parties and party officials to obtain or retain business, including bribes paid through intermediaries. It allows payments that merely “expedite” a routine official action (such as clearing a shipment through customs that is legally entitled to be cleared). If you form an entity in the U.S., both the entity and its directors, officers and employees, when acting on its behalf, are subject to the FCPA, even if all operations and personnel are located outside the U.S. So if you form a Delaware corporation and then bribe a local official to “overlook” some building code violations in your Gurgaon office, you’ve violated the FCPA. By contrast, if you formed your company in India and did the same thing, U.S. law would not apply. The FCPA is a criminal statute, so the consequences of violating it are potentially very serious. The federal government has enforced the FCPA very aggressively in recent years.
The United States has a very complicated set of laws and regulations governing the “export” of certain technologies from the U.S., as well as other commercial dealings between U.S. persons and certain countries (especially Cuba, Iran and North Korea). These laws normally don’t apply to foreign nationals resident outside the United States, except to the extent they actually conduct business in the U.S. If you incorporate a company in the U.S., however, you’ve created a U.S. person that is subject to them.
There are two major ways this can cause trouble:
First, the “export” regulations can bite you, even if you aren’t exporting anything from the U.S. (or doing anything else in the U.S.). To put it simply, if your U.S. company does types of business the U.S. doesn’t like with people or countries the U.S. doesn’t like, you might be violating U.S. law. As with the FCPA, these rules would not apply to you if you formed your company in India and did business from outside the U.S. Some of the prohibitions are intuitive (if you’re thinking about it), but a significant number are almost random. So it’s best to have an expert review what you’re doing to determine if there are any compliance issues.
Another thing to bear in mind is that if your company develops technology in the U.S. that is covered by export regulations, you may automatically have “export” issues. “Export” covers more than you might expect. If you are developing covered technology in the U.S., any disclosure to a nonresident foreign national (whether s/he happens to be in the U.S. or abroad at the time and whether or not s/he is an officer or employee of the company) will generally constitute an “export” of the technology. Depending on the technology and the country (yes, India is restricted), compliance may require nothing, reporting to the government or obtaining a license. Some of the categories of covered technology are obvious: If you’re dealing in weapons systems, missiles or nuclear technology, you’re probably restricted and need to pay a lot of attention. Other technology is not intuitive (e.g. some kinds of high-speed computers, “dual use” software and encryption algorithms). The regulations are so haphazard and complicated that it makes sense to find an expert to check if you’re covered. You won’t be able to figure it out yourself. By the way, the “export” part of these regulations will apply even if you form your company in India, so long as the technology is developed in the U.S.
The consequences of violating U.S. export regulations are potentially dire (including criminal penalties), so it’s best not to mess around. Normally, a quick review will determine that there are no issues, but it’s worth undertaking the quick review.
The two entities you would be most likely to use to “incorporate” a business in the U.S. are the corporation and the LLC. The equity holders in a corporation are called shareholders or stockholders and the equity holders in an LLC are called members. From a non-tax perspective, the LLC is generally preferable because it is more flexible. For example, an LLC can have a board of directors and officers if that makes sense, but it can also be managed directly by its members.
The normal income tax treatment of corporations and LLCs is very different. Corporations are normally considered to be a separate taxpayer. That means that the corporation pays income tax on its income. When it pays dividends to its stockholders, they are taxed again on receiving the dividends. By contrast, LLCs are normally not taxed separately. Rather, they “pass through” all of their tax attributes (income, deductions, credits etc.) to their members, who then pay tax individually. A corporation can make an election to be taxed on a pass-through basis. This is called an “s” election and corporations that make it are referred to as “s” corporations. Nonresident foreigners are not allowed to hold stock in an “s” corporation, however, so it’s not an option for you. For a more detailed discussion of various kinds of U.S. business entities and tax elections, look here.
As a rule, venture backed startups (and startups that hope to be venture backed) form as taxable “c” corporations, rather than as pass-through LLCs. There are several reasons for this:
Now that we’ve reviewed the available entities, let’s review how the U.S. taxes nonresident foreign nationals. First, it taxes income that is “effectively connected” with a U.S. business roughly the same way it would tax a U.S. citizen or resident. If that income results from an interest in an LLC that “passes through” its tax items to its members, the LLC is required to make a “withholding” payment to the federal government to cover the member’s liability. Second, certain categories of “U.S. source” passive income (such as dividends, royalties and interest) are subject to a flat 30% tax. This tax is, again, enforced by a requirement that the U.S. payor withhold it at the source. On the other hand, capital gains (e.g. from the sale of stock) are generally not taxed.
Both of these taxes are modified by a tax treaty between the U.S. and India. In particular, the rate of the flat tax on passive income is reduced to 15 or 25% (depending on corporate structure) for dividends, 10 or 15% (again, depending on corporate structure) for interest, and 15% for royalties. One unusual twist in the U.S. India tax treaty is that it gives particularly favorable treatment to income from consulting or technical services that are ancillary to the use of licensed technology. So it might be beneficial to develop the technology in India, license it to the U.S. entity, and then provide consulting/technical services (such as software maintenance and updates) for a fee. But it is worth reemphasizing that the U.S. doesn’t tax capital gains earned by nonresident foreign nationals. So if you’re not planning to move to U.S. at any point during the development of the business and your ultimate goal is a capital “exit” (i.e. a sale of the company or a sale of your stock in an IPO or a private secondary market), the best strategy might be to use a taxable corporation.
By the way, if you form your company in India and conduct business in the U.S., the U.S. might tax those activities under separate “branch profits” tax rules. Those rules are very complicated (and modified in important ways by the U.S.-India tax treaty). So if you decide to form in India but still plan to conduct business in the U.S., you’ll need to hire a tax lawyer familiar with those rules.
The discussion above should give you some general ideas, but bear in mind that it only covers U.S. treatment. I’m just not competent to discuss how the taxes will play out in India. It should also be apparent that the right structuring decision is going to depend on multiple factors (your personal situation, your investors’ situations, your business plans etc.) and will often involve difficult tradeoffs based on guesses as to uncertain future events. So you really need to get expert advice from someone familiar with U.S. and Indian taxes before you make any structuring decisions. That’s not just a boilerplate caveat. If you don’t get someone to review your particular situation and help you think through your best strategy, you could easily get things wrong in ways that will be difficult or impossible to fix later and could cost you astounding amounts of money, especially if things turn out really well for the business.
I hope this helps situate you. Good luck on the new venture!