Mini Multinationals — Understanding the Key Legal Issues
When we think of multinational companies we tend to think of large corporate conglomerates. We know, of course, that multinational companies also include small start up businesses that are seeking to sell products and services that benefit the communities in which they are operating. Unfortunately, the legal rules for Fortune 500 companies and the pre-revenue organization are the same – and are VERY complex.
The complexity of international business is especially apparent in the realm of US taxation. US companies with overseas operations have more extensive reporting obligations, and international tax rules often suggest a different form of entity than would be the case with a purely domestic strategy.
I highly suggest that entrepreneurs discuss their international plans with a knowledgeable lawyer and CPA prior to forming a US entity. Mistakes in this area can be extremely costly to correct.
I first prepared the below outline for a client with operations in about 10 countries, and later used it as part of a presentation for the Village Capital cohort in Boston. It provides a high level view of some of the legal issues that need to be considered for US companies and entrepreneurs operating overseas.
Overview of Applicable Law and Compliance Recommendations for International Operations
A. Compliance with US federal law
1) Foreign Corrupt Practices Act (“FCPA”). US companies risk civil and criminal liability if they or their foreign business partners make certain kinds of payments to government officials (including officers of state-controlled business enterprises), political candidates or to persons that they know intend to make such prohibited payments on the company’s behalf. The FCPA permits, however, payments to facilitate routine government actions, such as obtaining permits, utility service or police service. Here is a comprehensive guide to the FCPA.
i. Penalties:
a) Criminal fines of up to $2,000,000 for the company.
b) Criminal fines of up to $100,000 and imprisonment for up to 5 years for officers, directors, stockholders, employees, or agents.
c) Civil fines of up to $10,000 imposed on a strict liability basis (i.e. no intent is necessary to impose fines).
ii. Compliance recommendations:
a) Business practices and reputation of foreign consultants and business partners should be evaluated and measured against conduct expected by the FCPA.
b) Higher level of scrutiny over foreign partners is recommended if any business is conducted with foreign governments or state-owned enterprises.
c) Contracts with all foreign persons (including foreign affiliate and joint venture companies) should include FCPA compliance language.
d) Adopt internal accounting controls to provide reasonable assurances that material expenditures, including travel and business development expenses, are authorized by management.
e) Adopt a corporate policy statement against corrupt payments and provide a copy of the policy to foreign business partners.
2) Anti-terrorism/trading with enemy laws. US companies are prohibited from entering into commercial relationships with certain foreign persons, e.g. persons that are residents of certain blacklisted countries and persons on the US terrorist list.
i. Penalties:
a) Criminal fines of $500,000 or more, imprisonment of up to 20 years; civil penalties imposed on a strict liability basis.
ii. Compliance recommendations:
a) Before transacting business of any kind with any foreign person, the country of residence of that person should be determined and checked against the country blacklist and the identity of that person should be determined and checked against the terrorist list.
3) Foreign ownership reporting. Generally speaking, US companies are required to report ownership of a foreign company with the US Dept. of Commerce if ownership exceeds 10%. Reporting is not required, however, if the foreign subsidiary has less than $25 million in revenue or assets. Here is further information on foreign ownership reporting from the Department of Commerce.
i. Penalties:
a) Civil penalties of up to $25,000 for failure to file (on strict liability basis – knowledge of the law is not required).
b) Criminal penalties of up to $10,000 and one year imprisonment for willful failure to company. Applies to officers, directors, employees and agents of company.
ii. Compliance recommendations:
a) Timely report foreign ownership.
4) Foreign bank account reporting. US persons and companies are required to report to the IRS if they either have signatory authority over a foreign account or if they have a financial interest in foreign accounts that exceed $10,000 in the aggregate at any time. Financial interest in a foreign account will be deemed to exist if a US person owns more than 50% of a foreign company and/or a foreign account is controlled by someone working in a representative capacity. Here is further information regarding foreign bank account reporting.
i. Penalties:
a) Civil penalty up to the greater of the account balance (not to exceed $100,000) or $25,000.
b) Criminal penalties for willful violations of up to $250,000 or 5 years imprisonment or both (or more if violation is committed in connection with violations of other laws).
ii. Compliance recommendations:
a) Perform annual review of financial accounts to determine whether the Report on Foreign Bank and Financial Accounts (FBAR) applies.
b) Timely file FBAR reports (on or before June 30th of the year following the year in which compliance is triggered).
5) Withholding requirements for payments to foreign persons. Federal tax treatment of payments to foreign persons may differ from treatment to US persons. Withholding, for example, is required for payments to foreign consultants doing business in the US
i. Penalties:
a) If a US company fails to withhold and foreign person does not pay tax, the US company is liable for the tax and any associated interest and penalties.
b) 2%-15% penalty for failure to make timely deposits of withheld amounts.
c) Failure to timely file appropriate IRS forms can result in penalties of up to 5% of unpaid tax per month (up to a maximum of 25% of unpaid tax) and a $30-$100 fee per late form.
ii. Compliance recommendations:
a) All commercial relationships with foreign persons should be documented in writing to establish tax treatment.
b) Need to carefully consider payments to foreign persons if they maintain a US bank account or spend more than a few days a year in the US
6) Federal tax implications of foreign ownership. US taxpayers are required to report to the IRS ownership of foreign companies if the ownership exceeds 10%. If the ownership exceeds more than 50%, the foreign company will be considered a “controlled foreign corporation” (“CFC”). The rules for CFC’s are very complicated and extensive information about the CFC will need to be provided to the IRS. Under certain circumstances, the US taxpayer may need to pay tax on deemed income of the CFC, even if the CFC has not made a profit distribution.
i. Penalties:
a) Each failure to file information about a CFC carries a penalty of $10-$50,000.
b) The US taxpayer may lose the ability to claim foreign tax credits.
c) Penalties and interest may also apply if the US taxpayer should have paid tax on deemed income from the CFC.
ii. Compliance recommendations:
a) Hire a CPA who has experience with companies operating outside of the US These rules are very complicated!
B. Compliance with foreign law
1. Tax considerations. Generally speaking, if a foreign company is deemed to be “doing business” in a country, then that country will consider the foreign company subject to its tax regime. At the very least, the country will tax all income that it deems to be sourced from the country. Some countries may even seek to tax the global income of the foreign company. A foreign company can be found to be doing business in a country if it is found to have a single “agent” operating in that country.
i. Penalties:
a) Vary but can be severe. Brazil, for example, assesses penalties and fines that can equal up to 150% of the tax that should have been paid.
ii. Compliance recommendations:
a) Assess under local law whether activities or proposed activities would constitute doing business in the country.
2. General regulatory review. Local counsel should be engaged to advise on local law as it applies to business being conducted in that country. In particular, look at whether the core business is subject to regulation (e.g. whether a license is required) and whether there is any local law that applies to money transfers or other aspects of international operations.
