Considerations for Chinese Companies Doing Business in the United States

Chinese companies are increasingly considering expanding their operations directly in the United States.  For many, creating a business entity in the United States is a logical approach.  While a foreign company is not required to conduct business through a U.S. entity, and can establish a “branch office” instead, a branch office is often not advisable for tax, liability exposure, and other reasons.  For example, the officers of a Chinese company are less likely to be required to appear for a deposition in the U.S. if the company’s U.S. operations are conducted through a domestic entity even if they have overlapping officers and/or directors, a U.S. entity might help facilitate obtaining U.S. residency by the families of the company’s officers, and if the company seeks investors’ capital for its U.S. operations, such capital is often easier to obtain for a U.S. subsidiary.

Many issues need to be considered prior to creating a U.S. entity, the answers to which will depend on the unique circumstances and business objectives of the company and its owners.  The following is a non-exhaustive list of questions to be asked and steps to be taken in deciding how and where the parent Chinese company should create a U.S. entity.

I.   What business form should the entity use?

The most common forms of business entities in the U.S. are corporations, limited liability companies (“LLC”), and partnerships.  Each form has its own characteristics, and the choice will depend on the unique business and legal circumstances of the company. LLCs are now recognized by every state and they shield the owners from most liability like corporations; the primary difference is their tax treatment.   Corporations are taxed at a corporate rate while LLCs are taxed like partnerships with the distributable share of the profits taxed on the personal returns of the owner members.   With partnerships, the owners are exposed to personal liability.   Partnerships are used less given the broad acceptance of LLCs now.

Decisions should be made in consultation with the company’s legal and business advisors as the decision impacts tax liability, and potential exposure of the owners to various unique and widely varying state laws and regulations.

II.   In what state should the entity be organized?

Unlike China, the United States does not require most companies to be organized in the state in which it operates.  Instead, the company can select its state of organization considering such factors as costs, state laws, business logistics and other considerations unique to that company and its business strategy. The entity must establish a registered office in the state in which it organizes.  The registration process is relatively simple, and the company can pay an annual fee to a third-party company to act as its registered agent for service of process and notices if the entity’s primary office will be in a different state.  The entity will still be free to establish a business office and operations in another state or states.  Significantly, contracts entered into by the entity may contain a “choice of law” clause designating which state’s laws will be used to interpret the agreements it enters into.  Such clauses are generally enforceable.

Delaware is the most popular state in which companies organize for a variety of reasons, including what are widely considered to be its sophisticated and well developed business laws, regulations and judiciary.  New York is another popular location to be organized for similar reasons.  California is a common state for many Chinese companies and their subsidiaries in which to form and/or operate, but it has some potentially significant drawbacks for foreign entities unique to that state.  Although the company can be formed in any of the 50 states, a handful of states comprise most of business formations for a collection of good reasons.

III.  In what state should the entity establish an office?

Where the company will choose to establish its U.S. headquarters will depend on many factors.  As noted, the company will also need to register to do business in any state in which it does business.  In order to reduce costs, some companies choose to organize the entity in the state in which it primarily anticipates operating.  Many areas of law in the U.S., including employment law, contract law, and business regulations are primarily controlled by the individual states, which differ greatly.  Some are considered pro-business and others are not.  These areas of law may be of greater or lesser importance depending on the unique circumstances of the company.  Usually of great importance is location of American suppliers, customers, employees and contractors.

Intellectual property issues should also be considered when locating the new entity.  U.S. entities are more likely to be sued for intellectual property infringement in the states where they are incorporated or doing business.  Patent cases, for example, may only be asserted against U.S. entities in such jurisdictions.  If IP issues might be anticipated, then this should be weighed.  Some companies, for example, avoid having any place of business in Texas, which is considered to be a jurisdiction more favorable to plaintiff patent holders.

IV.  Should an intermediate holding company be formed in a third country?

The owners of the Chinese company will seek to minimize taxes and other costs incurred when repatriating cash from its U.S. entity back to the parent company in China.  Based upon China’s tax treaty with the U.S.,  a 10% withholding tax is applied to interest, dividend and royalty payments flowing from the U.S. to China.[1] This withholding tax can potentially be reduced or eliminated by routing the funds through an intermediate holding company established in a third country that has negotiated rates with China.[2]   In order to receive the benefits of these treaties, however, the company would need to establish a sufficient presence in the third country, which may include a registered office, employees and operations within that country.  The costs of establishing such a presence should not outweigh the tax savings for this strategy to be effective.  However, holding companies may also help shield the parent company from costly U.S. litigation exposure.

V.   Intellectual property considerations

i.  Selecting a Name – a critical trademark issue

When choosing a name for the entity, a search of both federal and state records should be conducted to ensure that the desired name is available in both the state in which it is formed and any states in which the entity will conduct business.  Searches of registered trademarks are relatively inexpensive, but as prior unregistered trademarks in use by other companies are enforceable regionally under state common law, more sophisticated state trademark searches should be conducted to avoid a costly later bar and/or lawsuit to block the company’s use of the selected name.

ii.  Legal Ownership of IP Rights

There are both costs and benefits of transferring intellectual property rights to a U.S. company.  It may be easier to defend or prosecute its intellectual property rights in a U.S. court if the patents, trademarks, or other intellectual property in question are owned by a U.S. subsidiary.

Conclusion

Given the multiple issues that should be considered before a Chinese company establishes a physical presence in the United States, and there are potentially severe ramifications if done improperly, consultation with experienced U.S. counsel such as Sills Cummis & Gross P.C. is essential[3].

[1]  https://www.irs.gov/businesses/international-businesses/china-tax-treaty-documents