Investors or enterprises who seek to establish a cost and resource-efficient legal presence in a U.S. jurisdiction or who aim to ultimately repatriate their profits to a U.S. jurisdiction with the greatest tax efficiency, then Delaware and Nevada offer outstanding characteristics.
By Chet Scheltema
Aug. 25 – Foreign invested enterprises (FIEs) in China face a heavy tax burden. Most encounter a corporate income tax of 25 percent, a business or value-added tax of 3-20 percent (per transaction), and a corporate dividend withholding rate of 10 percent. Confronting the issue of dividend withholding, some have located the parent of the FIE in a jurisdiction with which China has concluded a preferential “double taxation agreement,” thereby seeking to secure the benefits of such treaty’s preferential rates. For instance, Hong Kong, Singapore and Ireland are parties to DTAs with China, so any FIE holding company located in these jurisdictions is eligible for a 5 percent reduction in dividend withholding tax from the normal rate of 10 percent.
So why would any FIE in China not set up a holding company in one of these tax-advantaged jurisdictions?
Enter China’s Circular 601, issued in 2009, and further elaborated by Circular 30 issued in 2012. Circular 601 and Circular 30 are tax avoidance measures designed to ascertain true “beneficial ownership” and stop foreign investors from evading withholding tax by means of shell holding companies strategically located in jurisdictions that are parties to a DTA. To obtain the preferential withholding rate, FIEs must petition the Chinese State Administration of Taxation (SAT) and satisfy the standards of Circular 601 and Circular 30. Ultimate discretion lies with the SAT officers-in-charge, but Circular 601 and Circular 30 make it clear that an empty corporate shell strategically located in a DTA jurisdiction will not qualify. The holding company needs to look and feel like a real company, often judged by considering the size of its staff and operations, otherwise it may be branded a tax avoidance vehicle for which preferential rates are unavailable.
Because of the difficulty of qualifying for the preferential withholding rate, those foreign investors who ultimately wish to repatriate profits to a U.S. jurisdiction may want to reconsider the additional expense of creating and maintaining an offshore holding company and instead look at repatriating directly to a holding company located in a favorable U.S. jurisdiction.
Such U.S. corporate holding companies offer tremendous flexibility. They may be the ultimate destination for monies repatriated from China, they may be a pass-through vehicles (partnerships, S-Corporations, or LLCs) offering substantial tax savings to the ultimate shareholder, or they may serve other purposes in the investor’s broader financial strategy. Additionally, for U.S. non-profits needing to establish a for-profit corporate holding company to hold their China entity (wholly foreign-owned enterprise or representative office), establishing a holding company in a U.S. jurisdiction may also be a cost-efficient and resource-efficient option.
Deciding ultimately which state to locate a U.S. corporate holding company is a complex process, and many practical business matters should be considered, but several jurisdictions warrant consideration, including Delaware and Nevada (with Wyoming earning an honorable mention).
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