Given how a tech startup isn't really tied to a physical location, (Servers are rented, there is no brick store, founders can work from anywhere), where should one officially register the company?
1. If you're in the USA the game is to escape State income tax. You are pretending that your business operates out of a Post Office Box in Las Vegas and therefore you shouldn't pay income tax in California (for example)? Good luck. It's a dead loser.
Don't waste your time. Especially when you're a startup and have no profits to speak of anyway.
2. Again if you're in the USA, on the merits of using Delaware or Nevada compared to your own state to form a corporation or LLC . . . .
Forming your company in Delaware or Nevada and operating your business in California (for example) just adds overhead to your business. Unless there is a compelling reason to do otherwise, use the corporate law for where you are. Keep it simple. Look at Google. They started as a California corporation and later reincorporated in Delaware.
3. Onward to your second paragraph. Again if you are in the USA and you want to think about taxation of your business, think about where the humans are. That will give you a clue on how the business will be taxed. Pretend you are selling equipment leasing deals over the phone and making a commission on each deal you made. Who would want to tax you? Yep -- the state where your ass sits while yapping on the phone. There's nothing mystical/magical about tech stuff.
There are plenty of things you can do tax-wise that are cool. E.g., I have a guy who has a California corporation that makes money this way and he sits in the Caribbean and the first $192K of net profit every year is tax-free (half to him, half to his wife who is on salary). No State income tax to him because he's not living in California. Yeah, the 1.5% S corporation tax applies. He's living well.
4. Throw me a few more details and I'll give you more concrete suggestions.
How is that done? Google alert: "Transfer Pricing" is the game. Control the way in which sales are made so whatever you earn in California is offset almost entirely by operating expenses.
This is a point of obvious contention between the tax people and businesses. The tax people don't want you to artificially manipulate your business affairs to eliminate tax. There has to be an arm's length approach to how you do this.
It gets worse. Assume you have operations in the USA and Canada and India. Each country's tax collector would (logically) like to have you earn maximum profit in that country, and bugger the other places. So they'll pull out the local transfer pricing rules and say that you are artificially understating profit in that country. Now you're at risk of having the same $1 of profit taxed in two or three countries.
Yes there are ways to prevent this, and ways to fight back. But this gets expensive in lawyer and accountant fees. And buying expert opinions from economists about the esoteric meaning of "arm's length" in your particular business, etc.
When I said tech startup, i meant companies developing web applications that people pay for. So for example, if people use DropBox or Basecamp, and there is no guy making a commission, then you can only tax the company in which ever state it is in?
Also, what about incorporating abroad but having your customers in the US?
There are tons of exceptions. California thinks that if you come to a trade show for "too many days" in a year that is enough to cause presence for taxation for a non-California business. Every state tries to find some weasel-ass way to hook you and claim the right to tax your business. So be careful.
When you're thinking about doing business multinationally, the first thing to remember is that the U.S. tax law in the international tax world is written with two basic assumptions in mind:
1. All companies are of the size of Mitsubishi or larger, and operated by humans.
2. All humans are Colombian drug lords or worse.
You think I kid. No. The towering lunacy that is Washington DC has no bounds.
So when thinking about doing business across a border your PRIMARY concern should be paperwork costs, accounting costs, and brain damage. Your accounting costs and risks for accidentally f-ing something up will go up by an order of magnitude.
That aside, let me answer your question.
The variables in this equation are (a) the citizenship of the owners of the company; (b) the place of incorporation of the company; (c) the place of operation (might be multiple) of the company; (d) the source of the revenue (where are the customers?); and (e) the type of revenue (royalty, sale of a thing, etc.).
Starting from the simplest proposition. If the shareholders are U.S. people, a non-U.S. corporation will not affect US taxation at all unless it is a real live operating company incorporated in the place it is operating. If you're incorporated in Bermuda, for instance, you better have offices and bodies there doing the work. Otherwise the company is treated as a giant hose depositing net profit into the pockets of the shareholders.
For the Google fanatics: "controlled foreign corporation" and "Subpart F" income.
Now specifically on to your situation. When does it make sense to think of offshore corporations? You're a U.S. person starting a company and developing IP. You'll be exploiting that IP for fun and profit all over the world, eventually. If the amount of profit you're deriving from non-U.S. sources is big enough, you can create a system to defer (but not eliminate forever) the U.S. tax until you bring the profit home to your pockets.
I wouldn't bother until you have a couple million a year of profit from non-U.S. sources. The overhead is too big.
For a non-US owner with a non-US corporation, it is fairly easy to eliminate the US income tax bite on sales:
1. Don't have an office here (Google fans look up "permanent establishment" as a general clue).
2. The sale "occurs" outside the USA. (When ownership changes hands, that's when you look for where the profit was earned. E.g., you're buying toys from a factory in China. If you own them on the wharf in China, the guy selling them earned his profit in China. If you own them as soon as the container hits the deck at Long Beach, CA, then the guy selling them to you earned his profit in USA and he's cryin' and singin' the blues.)
Is the cost of setting up these entities falling? Rising?
The cost of professional services is the issue. The government lards on more and more stuff you have to do, and the penalties for mis-steps in international tax are huge. That is where the costs come in.
Worry about making something people want and making money at it - that's way more important than trying to wiggle your way out of taxes.
I'm not saying anything different than the path taken by ... well, pretty much everyone. Google, Microsoft, Facebook, Twitter, Oracle on down to things like 37 signals. They're all registered in the United States.
The ability to exclude income from taxation works for any U.S. citizen living abroad. The first $91,400 of earned income is free of U.S. tax. Look at Form 2555 from irs.gov. If you live in Germany you escape U.S. tax but you have to pay tax where you live, so there is no net savings. If you live in Antigua, the UAE, etc. where there is no income tax, life is good.
Warning though: you still have social security tax or self-employment tax to contend with.
The Netherlands Antilles has priced itself out of the market (well, and as such it doesn't exist any more, does it?) and has also introduced a very European corporate income tax.
Cayman companies are a tad pricier than BVI or Bahamas.
Twitter on the other hand has made me new friends in faraway places. Last time I was in Singapore I announced my arrival and a guy volunteered to give me the 2 hour tour. I've gone to cigar clubs in Riyadh and had a multip-person meetup in a Starbucks in a shopping mall in Dubai.
It's those human connections that make Twitter great for me.
If you're ever in Pasadena, CA -- @philiphodgen :-)
EDIT: I will be in San Francisco chairing the California Society of CPA's International Tax and Business Conference on December 7, 2010. I'll be flying up on Sunday, December 5. If you're interested in getting together for (geez I can't believe I'm saying this) free tax brainstorming shoot me an email at email@example.com.
Why did Google later reincorporate in Delaware?
Also, thanks for posting in this thread.
Really, wait until the company has enough money that it can get dependable advice and representation.
Assuming you're using the most common definition of "startup" (as distinct from "small business" or something like that), you want to use Delaware because it's what your potential investors' lawyers will already be familiar with - and the tax benefits, to the extent that they exist, of incorporating somewhere else are just not going to outweigh the added barrier to fundraising that you're going to create by going with some kind of funky tax haven.
Beyond just fundraising, Delaware really is still the industry standard, and in general you can set up a very solid corporate structure that will last you right through fundraising, bringing on your first employees, later employees, scaling, and all the way to sale/IPO without having to waste a lot of headache and lawyer fees later on because you're trying to customize all of this stuff for whatever jurisdiction you chose for tax reasons.
For any given startup, a marginally higher tax rate is a REALLY good problem to have. I wouldn't worry about taxes at this point -- worry instead that your startup will die before it ever makes enough money to be taxed in the first place (e.g., because you couldn't get funding because investors didn't want to bother with trying to understand your convoluted tax-minimization structure).
Bulgaria has a 10% rate on corporate profit and then 5% on dividends. This makes it quite appealing but the language isn't that nice and not sure if corruption isn't a problem there.
Cyprus is presumably also a good pick but I don't know much about it except the fact that the language is Greek so I wouldn't feel comfortable signing papers in something like that. Learning the language seems hard and using a translator for everything seems a bit of a hassle. Just as with Bulgaria, it might be worth it tax-wise but ignoring the language problem.
Jersey would be the ideal pick, they have a 0-10% tax rate there and it's all English but it seems that the island is more of a Gentlemen's club for big financial firms.
What I'm actually looking quite seriously nowadays for my own company is Luxembourg. They have a big tax rate of about 25% but they wave about 80% of it for intellectual property gains, giving you about 5% actual tax rate. Of course, you still have the 25% on the dividends.
I still haven't analyzed this enough as I still don't know what the total annual cost would be (accounting, rent, etc), but Luxembourg is looking quite good so far.
What we need is an actual index for startup friendly countries. There are all these statistics and lists but they all take into account big companies where you might need to hire locally or get some permits, etc. I've noticed no actual index for sofware startups which need basically low-cost, hands off (ie. as little involvement as possible) and preferably low-taxed entities. It might very well be a magical unicorn :-) and if you are American you won't gain much anyhow due to your fiscal system - that is if you ever want to pay any dividends.
I don't know about Luxembourg, but Belgium and the Netherlands also have special tariffs for high tech products. You'll want to look for specialized council though, most 'regular' accounts have no idea.
Thirdly, several countries like Panama have no corporate tax at all as long as you don't live there. Depending on what your life goals are, it may be an idea to build up a retirement account there. Again it is highly dependent on the circumstances.
I didn't knew Belgium and Netherlands have some special treatment for high tech products -- I'll look into it.
Regarding Panama, I have no information about them, but I'd personally keep things within Europe.
Re: 'just pay your accountant or lawyer', not to pounce on you but this is incredibly naive. Accountants and lawyers who spend 95% of their time doing mundane things like the books of the carpenter down the road are not qualified for this type of work. Any high-tech company owes it to itself to find highly specialized professionals, who will pay themselves back manyfold, even if you think they're expensive. (heck they are expensive. most charge 150 euro and hour or more, plus office overhead). Still when you're a real company (i.e. not doing 10k a year in iFart apps) it can be money well spent.
It was more of a joke, I was mostly trying to underline that I imagine this to be only for big companies.
Do these guys have a website ?
Anyhow, just the cost of the incorporation isn't the major criteria. I'm looking more at the total cost for such a thing: the total administrative costs over a year plus the total taxes must be well bellow what one would pay locally otherwise it's not worth the trouble.
As most expenses (accountant, rent) are rather fixed costs, this means that the whole thing becomes feasible only for companies that exceed a given income/profit.
I am not sure if you can file taxes without an accountant, but be prepared to pay through the nose for one. Both our lawyer and our accountant also gave us bad advice, like telling us we needed to register for VAT (we didn't), just to get more money out of us. A year later, the company owes the lawyer and accountant more than it ever made, without us ever seeing a single cent.
They take care of incorporating your company in different jurisdictions for a (relatively) cheap price. I'm incorporating in the British Virgin Islands with them next week. They can also introduce you to various banks around the world and help you with registration.
EDIT: See comment below by curt: http://news.ycombinator.com/item?id=1801105
Hong Kong offers an excellent alternative where it is much easier to setup payment systems, or even incorporate Paypal. Slightly more expensive per year as you need to pay for a local address and an annual audit. The accountant who sets up your company should be able to take care of both.
Right now we are using PayPal Website Payments Pro with my 'other' startup and it works like a charm (incorporated in the US with a US bank account / US paypal).
Also, how did you incorporate in the BVI? Any recommendations?
As for HK, you're right, however I'm not keen on incorporating anywhere near China for business reasons. If it wasn't for that I'd have incorporated there in no time, especially since HSBC allows you to open a bank account there, which means PayPal access + easy credit card processing (you do need to go there and meet the bank representative in person though, a one time thing).
..and oh yeah, I must add that the main problem with tax havens such as the BVI is that you will most probably run into problems with PayPal. You could incorporate / open a bank account in Luxembourg or Switzerland (see website above), but that will cost you $250,000 and $500,000 minimum deposits, respectively.
FWIW, this isn't tax avoidance advice - I'm personally incorporated abroad as I'm not American and can't open a business in the United States. If you need credit card processing incorporating a US business is probably the easiest solution. Otherwise, spend the extra $400 it will cost to incorporate in Hong Kong. The extra money is basically the cost for the accounting firm of running a virtual office and doing the perfunctory end-of-year audit. And you'll be able to setup Paypal directly using your corporate address and bank account. The only downside is you will need to pay taxes on SALES to Hong Kong residents. And you should figure out your local tax issues depending on where you live and work.
For what it's worth, I live and work in Asia and am in HK maybe 2-3 times a year and think your concerns aren't an issue. At least not for the next forty or so years.
Again, I'm not a lawyer, I'm not an accountant, what I described above is a mere guess and depending on state / federal laws and regulations YMMV.
There are jurisdictions with lower fees, though. If you really want to avoid taxes why not just incorporate in an offshore tax haven?
If this is advantageous, why do I hardly ever hear of it happening?
If you take your startup offshore, where will the court cases happen if things go wrong?
It's slightly favorable tax-wise (it's got a relatively simple code) and had a high cap on interest (which banks can no longer export, IIRC) - but mostly it's the judicial system that makes it popular.
- 20% is still the biggest single item in the budget.
- Many military-related expenses are not being paid for at present and will need to be paid for with future taxes.
On the other hand, there are folks who genuinely believe that taxes should be zero. They're welcome to move to Somalia.
Larger companies will often do this by setting up a corporation in Ireland. They get a favorable tax rate, 12.5%, and a legit and stable place to park their European cash flows.
My resource for looking up tax havens is, http://www.lowtax.net/lowtax/html/jurhom.html
Depending on the state you incorporate in and the number of shares outstanding you have, there may be fees on a per-share basis that you should check into.
Payroll taxes vary from place to place, but there's not much you can do about it--you have to pay them for the state where you're located. California currently has four types of payroll taxes: income tax withholding, unemployment insurance, the employment training tax (ETT) and state disability insurance (SDI). (See http://www.edd.ca.gov/payroll_taxes/rates_and_withholding.ht...) You can deduct SDI you've paid for the year on your 1040.
The type of corporation matters, too. The California corporate franchise tax rate for S corporations is 1.5%. For C corporations it's 8.84%. This only matters for startups that actually are bringing in revenue--otherwise you just have to pay the $800 minimum--but if you are actually making money it's a pretty big difference.
I'm not a CPA, just for the record.
Moreover, the bigger deal, on a state by state basis, is personal income tax.
California is about 10%, and they have a $1000/year franchise tax to run a business.
Nevada has no state income tax and no franchise tax.
Let's assume you are in one of the higher tax countries, such as Denmark.
You incorporate your SaaS company in Ireland, place servers in Netherlands, pay yourself a reasonable salary(pay Danish taxes on that), pay Irish corporate tax on gross profits after that.
Now, your company still has some retained earnings in its account.
Are those earnings free to move around the world (ie buy colocation in Germany, hire programmers in Ukraine, buy real estate in Caymans, stocks in US), as long as the expense is justifiable, or perhaps there is no need for justifications at all, just buy anything at all?
I realize I am mixing assets and expenses in my examples.
If at some point I decide to sell the whole company to someone, I pay capital gains taxes(or income taxes), but not before then, that is the main goal.
In other words, how do the corporate assets and individual assets work when one is the sole owner of the corporation?
But more than all, say you have made it, and it was a great success, and in your bank account there are 2.5 million dollars. Now you live in NYC and wish to buy a house with this money. How would you bring this money into the US? Would you make a wire transfer to your seller? He would then have to go to authorities and explain those 2.5M. Will you go cash it and carry it on your body while flying back home, does this make sense?
This is what my CPA have told me when I suggested to open up a company in Cyprus few weeks before I signed a big contract.
That 2.5 million is personal income and wealth, no matter where it's stored. America taxes it's citizen's and green card holders globally after the first $100'000 annually even if they are no longer resident. So unless you don't want to report that income and smuggle it in, which your CPA was alluding to, it would be already taxed appropriately. If it's under the corporation's name, then there will be procedures to go through. But don't let that dissuade you from saving yourself millions to hundreds of thousands of dollars in avoided taxation. The idea is to structure yourself that you don't have to lie, hide and put yourself under legal liability that you can still be in the open, they'll know how much is in your bank account and get what you want. You'd be in a much better position with your $2.5 million out of the country and then you can choose at your leisure on how to structure it vs. before the fact.
I think your CPA, like most accountants, has zero experience with international taxation laws in relation to the US and whatever jurisdiction you chose and still wanted to keep your business, so he dissuaded you from doing that.
Like most places though, you'll probably be taxed as a domestic corporation if your main office & management is there even if you incorporated in panama or wherever. The tactic only really works if your a multi-employee business bigger than a dozen people. You would have your head office in singapore and a loss-accruing development office in palo alto or somewhere similar if you wanted to be close to the bay area culture and pulse.
But the standard state to incorporate in is Delaware, even if its not necessarily the lowest taxes anymore, its still the state most investors, lawyers and tax pros are accustomed to.
But don't forget, you still have to pay taxes where you operate. So even if you incorporate in Delaware you still have to pay taxes where your home office is.
You can always reincorporate when you're cash rich.
Build and run your company in Wyoming. There's no state income tax for corporations or people. Maybe you can teach wolves and cows to write Ruby. Forget Java; Wyoming's climate is too cold for monkeys.