Foreign Incorporations 101: Ten Things to Consider When Incorporating Abroad
By Irina Shestakova and Daniel Robyn, Baker & McKenzie LLP
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.
1. Identify What Type
Of Entity You Need
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:
- A subsidiary (e.g., corporation or LLC) is a legal entity separate from its parent company. The parent is generally not liable for the debts or obligations of its subsidiary; the subsidiary can typically enter into contracts and engage in a wide range of other business activities allowed by local law.
- A branch is not a separate legal entity. It is a mere extension of its head office and, as a result, the head office will be liable for all debts and obligations of the branch. Although a branch can typically engage in profit generating activities, the types of activities may be limited depending on the jurisdiction (for example, a branch office in India may not engage in retail trading activities).
- A representative office (RO) is not a separate legal entity either, and, as such, it does not afford any protection from its local liabilities/obligations to its head office. Unlike branches, ROs cannot engage in profit generating activities. In most jurisdictions, the activities of ROs are limited to marketing, liaising with customers, gathering information, and other non-income generating activities. Registering an RO in countries like China, Indonesia, or Thailand can be burdensome and time-intensive (e.g., in China the company forming an RO must have been in existence for at least two years).
2. Determine Your
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.
3. Know Your
Corporate Name Requirements
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.
4. Know Your
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.
5. Comply With
Director and Officer Requirements
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 Argentina, the majority of the board of managers (of an Srl) or of the board of directors (of an SA) must be domiciled in Argentina. A Brazilian Limitada is typically formed with a Brazilian resident as its manager because the appointment of an expatriate manager is tied to strict visa requirements.
- In a French SAS, a U.S. citizen could be appointed as its president, but this would require the approval of the French authorities (and obtaining an FBI clearance certificate for the U.S. individual, which can take a couple of months). Therefore, the practical approach is to appoint, at least for purposes of incorporation, an EEA (European Economic Area) national who does not have to undergo this approval procedure.
- No residency or citizenship requirements apply to the directors of an Indian Private Limited company, but India imposes onerous registration requirements on directors such that they will have to obtain a Director Identification Number (DIN), a Digital Signature Certificate (DSC) to make online filings with the Ministry of Corporate Affairs, and an Indian Permanent Account Number (PAN), which can be compared to a social security number. Similarly, Hungary, Portugal, and Spain do not impose residency or citizenship requirements on directors of local subsidiaries, but U.S. individuals acting in that capacity must obtain a taxpayer ID (Hungary and Portugal) or a foreigner ID (Spain) prior to incorporation, which can delay the incorporation process.
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).
6. Know Your
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).
7. Have a
‘Real Estate’ Plan in Place
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.
8. Deal With ‘Time Bandits’ Early
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.
- Government approvals. The requirement for foreign government approvals can have a substantial impact on timing (e.g., in Indonesia a foreign investor must first obtain an Investment License from the Capital Investment Coordinating Board before a foreign-invested LLC (PT PMA) can be formed).
- Documents with long lead times. As part of the formation process, a parent is required to produce certain corporate documents (e.g., certificates of incorporation and good standing, certificates of secretary confirming the signature authority of certain officers). To be acceptable abroad, they must, in many instances, be notarized and/or legalized (by apostille under the Hague Apostille Convention, or by “consularization”) and translated into local language, which can be time consuming.
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.
- KYC requirements. Most jurisdictions have enacted stricter anti-money laundering laws which oblige financial and other institutions to comply with “Know Your Customer” (KYC) requirements that may consist of lengthy questionnaires tailored to gather information about the structure and the financials of the parent or the individuals to be named as directors, officers, or shareholders. Providing information and documents in response to KYC questionnaires can be burdensome and may take weeks.
- Opening of bank account. The incorporation process in some jurisdictions requires that a bank account be opened prior to incorporation of the foreign entity. In Germany, for example, the registration of a GmbH in the commercial register can occur only if the GmbH’s bank account has been opened and the required minimum capital has been wire-transferred. Similarly, a temporary bank account of a Russian LLC must be opened and payment of the required registered capital (to be made in local currency and by the specific legal entities that are proposed as shareholders) must have occurred prior to incorporation (similar rules apply in Bosnia, Bulgaria, Croatia, Latvia, etc.). Opening bank accounts abroad may take time and a U.S. company is well advised to coordinate at a very early stage of the incorporation process with the local banks to assess the information and documents that will be required.
- Mandatory name reservation requirements. In some jurisdictions (e.g., China, Malaysia, Portugal, South Africa) it is mandatory to reserve the proposed name of the foreign company, and to have it approved by the local authorities before the entity can be incorporated. This may add several weeks to the timeline.
- Other. Local holiday schedules may vary significantly from the United States and should be checked. The availability of signatories should be determined and “backup” signatories should be appointed, if necessary.
9. Consider at What Point Your Foreign Entity Can Do Business
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).
10. We Have Incorporated.
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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