Regulation of International Business Entrepreneurship Institute July 22, 2010 Prof. Gonzalo Freixes A legal and tax perspective

2 The Case of the Bollywood Film Distributors Bollywood Distributions (BD) wants to set up film distribution operations in the United States. Prof. Gonzalo FreixesConfidential

Foreign Investment in the U.S. Prof. Gonzalo FreixesConfidential3

Typical Options for Foreign Co. 4 BD US Co. BD US Reseller BD Prof. Gonzalo FreixesConfidential

5 Typical Options for Foreign Co. Form U. S. Domestic Business Entity Contracting with U. S. Re-seller/Agent Operating a Branch Office in U. S. Prof. Gonzalo FreixesConfidential

6 Business Form Considerations Formalities required Liability of owners Management structure Transferability (ability to sell) Taxation (separate vs. flow through) Prof. Gonzalo FreixesConfidential

7 Entity Taxation Example: $ 5 M Owners $ 10 M Prof. Gonzalo FreixesConfidential

8 Taxes Paid by Corporation Entity pays $ 3.5 M ($ 10M x.35) Owners pay $ 750K ($ 5M x.15) 2010 $ 2M ($5M x.40) 2011 TOTAL PAID IRS: $ 4.25 M 2010 $ 5.5 M 2011 Prof. Gonzalo FreixesConfidential

9 Taxes Paid by “Flow Through” Entity pays $ 0 Owners pay $ 3.5 M* (Individual Taxes on $ 10 M) TOTAL PAID IRS: $ 3.5 M* *3.96M in 2011 Prof. Gonzalo FreixesConfidential

10 Business Form Options General Partnership/Joint Venture Limited Partnership “C” Corporation “S” Corporation Limited Liability Company Prof. Gonzalo FreixesConfidential

State Regulation Corporate Regulation is left to the States California vs. Delaware Prof. Gonzalo FreixesConfidential11 VS

12 Contract with U. S. Re-Seller  Governed by CISG (Convention for the International Sale of Goods) not INDIA  Place of sale – title & risk of loss  Negotiate jurisdiction & conflict of laws  Financing & currency issues  Confidentiality & Non-Competition Prof. Gonzalo FreixesConfidential

13 Operating a U. S. Branch Immigration Issues employees/owners Must comply with local business regulations (e.g. Business License) Taxation: Subject to U.S. Income Tax + Branch Profits Tax (TBD) + (perhaps) home country taxation Prof. Gonzalo FreixesConfidential

Focus on U. S. Taxation Foreign Company invests in U.S. U. S. Company invests abroad Prof. Gonzalo FreixesConfidential14 BD US Co.

INBOUND TRANSACTIONS Prof. Gonzalo Freixes15Confidential

Typical Options for Foreign Co. Forming a U.S. Business Entity Contracting with U. S. Re-seller/Agent Operating a Branch Office in U. S. Prof. Gonzalo Freixes16Confidential

U. S. Taxation (Inbound Business) Passive Investments  Interest, Dividends, Rents, Royalties Active Business Profits  Selling goods & services in the U.S. Prof. Gonzalo Freixes17Confidential

Tax on Passive Investments Called Tax on “Fixed or Determinable Income” or “Withholding Tax” Flat 30% No deductions allowed Prof. Gonzalo Freixes18Confidential

Tax on Business Profits Called Income “effectively connected with a U. S. trade or business” Includes: Services, sale of inventory, rental real estate, manufacturing, etc. Taxed at Corporate Rates (15% to 35%) or Individual Rates (10% to 35%)* *39.6% in 2011 Prof. Gonzalo Freixes19Confidential

Tax Issues – Related Companies IndiaCo creates US Subco IndiaCo sells products to US Subco Subco sells to U.S. customers Tax consequences? 1. Will India tax the profits of each? 2. Will US tax the profits of each? U.S. SubCo Prof. Gonzalo Freixes20Confidential IndiaCo

Source of Income Rules Income = where service or sale took place. Shift income to foreign nation by transferring Title & Risk of Loss IRS allows Parent/Sub to allocate income 50/50 (US & foreign nation). Prof. Gonzalo Freixes21Confidential

New Tax Issue – Sub v. Branch IndiaCo creates US SubCo (Subsidiary) TAX 1: US SubCo pays taxes on US profits US SubCo pays dividends to IndiaCo TAX 2: IndiaCo pays dividend tax IndiaCo operates BRANCH instead Does this avoid “double taxation?” Prof. Gonzalo Freixes22Confidential

Branch Profits Tax Foreign Company’s U. S. Branch will pay income tax on U. S. income + Branch Profits Tax of 30% on income withdrawn (Called “dividend equivalent amount”) Prof. Gonzalo Freixes23Confidential

Effect of Tax Treaties Reduces “double taxation” by U. S. and foreign nation Example: U.S. and India - Dividends & Interest taxed at 15-20% Prof. Gonzalo Freixes24Confidential

New Tax Issue IndiaCo manufactures at $ 1 per unit Assume India has 25% tax rate India sells to US SubCo at $ 1.95 per unit US SubCo sells in U.S. for $ 2 per unit US has 35% tax rate U.S. SubCo Prof. Gonzalo Freixes25Confidential IndiaCo Who will tax profits? 95¢ 5¢ 35% 25¢

Transfer Pricing IRS may re-allocate income between related companies Will look at “comparable unrelated sales” Prof. Gonzalo Freixes26Confidential

Tax on U. S. Subsidiary U.S. Income subject to U. S. Corporate Tax (35%) Dividends paid to foreign parent subject to 30% flat tax. Treaties lower rates (India = 15%) Watch out for Transfer Pricing Prof. Gonzalo Freixes27Confidential

Tax on U. S. Partnership/LLC Foreign companies taxed on “flow through” basis but subject to Branch Profits Tax!! Flow through income = “effectively connected with U. S. trade or business”. Owners will pay at corporate or individual rates on “flow through” income Prof. Gonzalo Freixes28Confidential

Tax on U. S. Re-Seller or Agent Income taxed where “sale” took place May be U. S. or foreign nation Focus on contract language Prof. Gonzalo Freixes29Confidential

OUTBOUND TRANSACTIONS Prof. Gonzalo Freixes30Confidential

Outbound Taxation - Basics U.S. Taxpayers (including corporations) pay U.S. taxes on all worldwide income. Foreign Subsidiaries of U.S. Companies do not (unless profits “repatriated”). Prof. Gonzalo Freixes31Confidential

Outbound Taxation - Problems For U.S. Taxpayer: Double Taxation For IRS: Offshore Companies Prof. Gonzalo Freixes32Confidential

Outbound Taxation - Solutions For U.S. Taxpayer:  Foreign Tax Credit  $ 91,500 Exclusion  Tax Treaties Prof. Gonzalo Freixes33Confidential

Outbound Taxation - Solutions For IRS:  Subpart F Income  Controlled Foreign Corporation (> 50% control or stock value)  Foreign Base Income (no indigenous economic connection) Prof. Gonzalo Freixes34Confidential

Tax Rates: India v. U.S. Tax Rates: India v. U.S. TYPE OF TAXU.S. TAX RATEIndia TAX RATE Corporate Income 35% 35% (domestic) 40% (foreign) Individual Income 10 – 35% (2010) 0 – 30% 15 – 39.6% (2011) (+10% levy on rich) Capital Gains 15% (2010) 20% (Long Term rates) 20% (2011) Prof. Gonzalo Freixes35Confidential

Intellectual Property in U.S. First Use Doctrine (TM & Copyrights) Copyrights (Federal Regist.) – 95 yrs. Trademarks (Federal or State Level) Patents (Federal Regist.) – 17 years Prof. Gonzalo FreixesConfidential36

International IP Registration Paris Convention: National Treatment Patent Cooperation Treaty: 30 mos. To file Madrid Protocol: Central filing for TM’s Berne Convention: National Treatment + Minimum Standards for Copyrights ICANN: Domain Names TRIPS: WTO enforcement of Paris & Berne Prof. Gonzalo FreixesConfidential37

Labor & Employment Issues Employee v. Independent Contractor At will employment Discrimination Laws: U.S. & State Hours, overtime, minimum wage Payroll Taxes: FICA Workers Compensation Prof. Gonzalo FreixesConfidential38

39 Securities Regulation Federal: Securities Act of 1933  Covers sale of any investment to the public  Requires registration unless issuance exempt States: “Blue Sky” Laws  Requires registration in each state  California: Requires permit unless exempt

Tax Rates: China v. U.S. Tax Rates: China v. U.S. TYPE OF TAXU.S. TAX RATECHINA TAX RATE Corporate Income 35% 25% 16.5% (HK) Individual Income 10 – 35% (2010) 5 – 45% 15 – 39.6% (2011) 2 – 17% (HK) Capital Gains 15% (2010) 20% 20% (2011) 0% (HK) Prof. Gonzalo Freixes40Confidential

Prof. Gonzalo FreixesConfidential41 Choosing Business Entity China, Hong Kong & U.S. U.S.CHINAHONG KONG PartnershipCooperative JVPartnership Limited PartnershipNoneLimited Partnership L.L.C.Equity JVL.L.C. CorporationCompany LimitedPrivate Limited Company by Shares Public Limited Company or Equity JV