Category Archives: Company Formation

An Analytical Model for Evaluating Strategies

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People often ask me, “What is the best business structure/solution for global business?”

This is a very good question, but sadly leads to some very bad answers. People have a tendency to look at solutions in a rather simplistic manner, and then get surprised when their solutions do not really work. They go from “This is the greatest thing ever!!!” to “This is the worst thing ever!!!”

I prefer to use an Analytical Model to answer this question. This requires some time and patience.

Part of the problem is how service providers tend to market their products. They tend to focus on specific jurisdictions. Frankly, even I find myself doing this. Most of this website is aimed at selling my services to help you set up a US Limited Liability Company that can be used to give you access to banking, merchant services, investment opportunities, etc.

However, I begin my evaluation of a prospective client’s circumstance by analyzing his situation. I have a simple but important Analytical Model to help me to better understand what would be best.

I like to think of the various options as tools that can be used to help people do business. These tools are varied and depend a great deal upon what is needed. As the old saying goes, “If the only tool you have is a hammer every problem is a nail.” This way of thinking is unfortunate, dangerous, and unnecessary. I like to think of the various options as different tools in my tool kit. Some work better for some problems, others work better for others.

My first line of questioning is to discover the client’s current residency issues: What is your citizenship? Where are you living? Where would you like to live? What are the tax rules?

Not all countries are the same. For instance, someone from Sweden has almost no problems regarding residency if they want to “opt-out” of the system. They more or less only have to leave. People from other countries often have to deal with some remarkably difficult obstacles. So before I start talking about US LLCs, or UK LPs, or Georgian JSCs, etc. etc. etc. I first want to understand this issue.

Then I ask, “What do you want to do?” I like to know what you want to accomplish before I start trying to sell you a solution.

Yeah, I know that’s crazy.

Once I better understand the issue of residency and what the client really wants to accomplish, only then can I start thinking about which business structure(s) might be best. This is an area where people get very confused. Some company entities are better for certain situations than others. Some jurisdictions work better for some clients than for others. You have to take it case by case.

The biggest problem I encounter is “jurisdictionitis“: the irrational belief that one jurisdiction will magically solve all your problems. Even for the best of jurisdictions this is not the case. Delaware can be great for one client, and Texas might be better for another. The same goes for different countries as well.

For one client I spoke to about a year ago, because of his unique business and family situation combined with his citizenship, the ideal solution would have been very simple:

  • to establish a residency in the Republic of Georgia due to its Territorial Tax Treatment,
  • a US LLC to manage his global professional consulting business, and
  • a Georgian company to establish a new Internet venture.

Georgian residency would have been ideal since it is a “territorial” tax country for individuals (that is you only have to pay taxes on income you earn inside the country — thus his consultancy business outside of Georgia would never be taxed), and his country of citizenship would have then considered him a non-resident and he would owe no taxes there. The US LLC would have allowed him to easily gain access to US banking making it easier for him to get paid from his US-based clients while avoiding US taxes since his business is outside the USA and the US LLC would be a considered a “disregarded” or a “pass through” entity in regards to US taxes. Finally, the Georgian company would have been ideal for the Internet venture because of something called the Virtual IT Zone Company which is a terrible name for an awesome tax exemption; any company in Georgia that is doing business in what the government loosely defines as IT can request a tax exemption for all income earned outside of the country in the IT industry — thus tax free.

Although these three separate solutions would not have been terribly expensive to set up or manage, and would have effectively resolved 100% of his problems, he only wanted one “thing” that would do it all for him. I honestly do not know of any such single “thing” that will accomplish all these tasks, but I hope if and when he finds it he will let me know — though I am not optimistic. I rather suspect he will end up getting cheated by some unethical internet personality claiming to be an expert who will lie to him, tell him what he wants to hear rather than the truth, and then sell him some outrageously priced solution that will not actually work for anything, and will most likely get the man into a great deal of legal trouble.

So there you have it. My Analytical Model for how to resolve these problems: analyze the residency issues of the proposed client, find out what the client actually wants to do, and then find the appropriate tool(s) to address those issues.

Royalty Financing – Misunderstood or Mysterious?

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There are three ways that a business can finance its operations and development:

  • Debt
  • Equity
  • Royalty

The first two are the most common and the easiest to understand.

Debt financing simply means borrowing money without giving up actual ownership of any assets. Often lenders will require some kind of security interest or lien against those assets, but as long as you pay your debt properly you do not give up any of your business, your assets, or your revenue.

Equity financing is the process of raising capital by selling shares or ownership interest in your business. How this actually takes place will vary according to the size and strength of the company brand and finances. An established company finds it much easier to issue shares than a start up venture. Start up ventures often have to give up majority control of their company in order to receive funding from Venture Capitalists.

So what is Royalty Financing?

Royalty Financing is often referred to as a “new concept” in investing, however, this is not really true. Royalties have been around for quite a long time. Royalties are what someone receives in exchange for allowing a business to use some kind of valuable asset, or in some cases just money. The most traditional form of royalties usually involve some form of intellectual property such as music, books, or other artistic endeavors which the artist licenses to the company in exchange for a fixed percentage of the sales. Royalties are also very common in regards to licensing of scientific properties such as patents and designs. The royalty can be compared to a sales commission, only the receiver of the royalty does not have to perform any additional tasks to receive the payment.

What is somewhat novel is the idea that investors can receive royalties from the sale of a product or service in exchange for a fixed investment that is often used to further develop the business opportunity. The most common means of royalty financing is to give the investor a fixed percentage of the revenue of the business or the revenue from the sales of a specific line of products or services.

There are many advantages to a royalty financing arrangement:

  • The most obvious advantage for the business is the fact that the company remains in control of its own destiny while facing fewer risks associated with borrowing money.
  • Easier regulatory environment. Since no shares in the company are being sold securities regulations should not apply.
  • It can also be easier to obtain royalty financing when future revenues are predictable and consistent even if other factors may be more risky.
  • Royalty financing is more flexible than equity or debt financing since the royalty payments will vary according to the revenue rather than upon some preset fixed amount. In good years royalty holders will receive higher payments, and in bad years lower payments. This gives the company the ability to better withstand the possibility of future downturns while giving the investors greater opportunities to participate in the upturns that may occur.
  • Royalty payments are usually tax deductible from the company’s gross income thus lowering the company’s tax liabilities, and also avoiding the double taxation that often occurs with dividend or profit sharing payments.
  • Because the company does not have to give up equity in order to obtain financing, the company can often focus more on operations, and less upon exit strategies of the founders and initial investors.
  • Finally, royalty payments are more secure for the investors since the payments are based upon a percentage of the gross sales or revenue rather than profits. Even if the company is unprofitable, if it makes any sales the investors will receive the benefit. It is also much more difficult to use obscure accounting methods to conceal, reduce, or eliminate a company’s gross revenues than profits.

Royalty financing is not ideal for every business. Businesses that lack predictable and consistent future revenues will find it very difficult to successfully obtain such financing. Also, royalty financing may turn out to be more expensive than equity or debt financing, even if it is more flexible for the company and more secure for the investors.

Sometimes royalty financing is misunderstood, but it is never a mystery. It is just a very convenient way for some businesses to attract financing that would otherwise be difficult or impossible to obtain otherwise.

How a US LLC can Uniquely Benefit a UK Resident

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A prospective client approached me recently regarding the benefits of establishing a US Limited Liability Company (US LLC), becoming a non-resident of the UK, and in which order should he proceed. Due to the unique status of how the UK interprets US LLC status, residents of the UK can receive some very unique benefits if they neither incur US or UK “effectively connected income”. This was my answer:

Well I first must fully agree with you about non-res status. It can be a real deal changer. However, in your case it is not absolutely necessary, and I would feel free to proceed with a company formation prior to actually leaving the UK.

If you own a US LLC it will be treated very oddly because of the way that the US and the UK deal with how US LLCs are treated for tax purposes.

In the USA the default setting of the US LLC is “disregarded entity” which means it does not exist for US tax purposes. So if you do not live in the USA and you do not earn “effectively connect US source income” then you will owe no US taxes. In fact you will not even have to file tax returns. This will be the case even if you have a US bank account and do all your banking in the USA. Just receiving money in the USA, even if that money comes from US sources, does not create a tax liability. For that you need to do more; make things, store things, deliver things, maintain permanent offices and staff, etc. from inside the USA.

Now that all sounds pretty good! However, it only gets better for citizens of the UK. Even though the US considers the US LLC to be a “disregarded entity” the UK treats the US LLC as a separate entity. If the US LLC does no business in the UK and incurs no income in the UK then there will be no UK taxes due from the income earned by the US LLC. Now you will need to pay taxes on income you receive as a salary or profit distribution, but you will be able to provide yourself with many tax free benefits since the US LLC will have no taxes to pay anywhere. Money you do not distribute to yourself, or use for your personal benefit will be deferred taxation allowing you to further invest that money. Now it is wise to be careful about how you give yourself these “tax free benefits” since the UK may decide that what you are really doing is giving yourself income and then fraudulently evading taxes; not good. So don’t be greedy. If you are receiving real economic benefits while living in the UK then pay taxes on that income. Keep in mind that you get to choose how you get paid and can select the method with the least tax; profit distributions, salary, reimbursement for contract work, etc. You get to choose whatever is best for you, but again don’t be greedy.

This takes us to the interesting issue of how to really avoid UK taxes. Move out of the UK. I am not a UK attorney, and I do not even pretend to play one on TV, but it is my understanding that in order to gain full non-resident status you must do more than just leave the UK and stay out a certain number of days. You must also obtain a legal residency in some other country. In this regard there are a lot of interesting options out there.

I chose the Republic of Georgia for a number of reasons. For me it was mostly lifestyle issues and economic opportunities, but there are also a lot of tax benefits to be had here. Getting a residency is simple and easy, and it can lead to citizenship for some in under a year! I don’t know of any place else on earth where that is possible without some sort of ancestral claim or a huge investment in the country; at least not a country that I would actually want to be part of.

Some other interesting options that provide great tax benefits: Montenegro, Mexico, Malta, Latvia, etc. Each has its advantages and its disadvantages. Note, you do not necessarily have to live in the country that you have a residency. It might just be a legal formality so that you can claim non-res status. On the other hand it might be nice to combine the issue of tax status and where you like to live.

“Disregarded Entity” vs “Taxable Association”: What is the best way to structure your LLC?

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For the past 15 years I have been promoting the USA as the ultimate banking solution for non-residents (or as some might say a “Tax Haven” for non-residents). My traditional proposal was to simply set up a US LLC, take the default election of ‘disregarded entity’ (“disregarded entity” is an LLC that is treated by the Internal Revenue Service as a complete pass through entity. For tax purposes it does not exist. For all other purposes it does.), open a bank account, and as long as you are not earning any US Source/Effectively Connected Income, you are fine. No need to file tax returns let alone pay any taxes.

That is no longer entirely the case. FATCA has not changed the tax treatment issues, but has changed the reporting requirements for US payors. The issue of the W-9 (reporting form for US resident payees receiving funds) and W-8Ben (reporting form(s) for non-US residents receiving funds) was always a little murky but now it is downright impossible. Non-residents receiving payments from US payors, even if the funds are “not effectively connected” to US income, are now facing serious problems. No one really understands how the new W-8Ben system works since they have replaced the one form with 4 or 5 related forms that no one really understands how to use. And the penalties for getting it wrong are quite serious so payors are paying a lot more attention, or just choosing not to do business with anyone who cannot execute a W-9.

In short, it has become very difficult for non-residents to use their US bank accounts to receive funds from US payors.

My solutions:

For those non-residents who do not need to receive funds from US payors, the Disregarded LLC is still fine. Nothing to worry about.

For those receiving money from US payors, we need a more sophisticated structure. The US LLC will elect to be a ‘taxable association’ (that is an entity that will be taxed separately like a C Corporation), but it will only act as an agent of a non-resident business (with a written agency agreement) to resell non-resident goods and services in the USA. 90% of the gross income goes to the foreign provider (with appropriate W-8Ben — that will be very easy), and all operating expenses will come out of the 10% agency fee — there should be little or no taxes.

This solution is simple and easy to implement. In fact old Disregarded LLCs can be converted to “Taxable Association” LLCs with little effort. The only downside is that there is now a requirement to file an annual tax return which means there is a requirement to maintain a good set of books so that the tax preparer can accurately file the return. There may be no taxes due, but failure to file a tax return can cause a lot of problems. I have always advised my clients to maintain a set of books for professional reasons, but they were not required for US tax purposes. Now they are.

If you have any further questions please do not hesitate to contact me.

Why a United Kingdom Limited Partnership?

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business_2172838bFor clients who wish to protect their assets, reduce their taxes, and obtain financial privacy using a corporate entity is ideal. One of my favorits is the United Kingdom Limited Partnership (UK LP).

The UK LP is easy to establish, and once established requires zero reporting since it is a truly 100% “pass through” entity. The income from the UK LP is attributed to the partners without the need to file a partnership return in the UK. If the partners are not in the UK and the income is not derived from UK business, there will be no UK taxes and thereby no reports or tax returns that need to be filed. Now since the UK has some of the best tax treaties around, this income may also be tax exempt in your home country.

In addition, as long as you are not “doing business” in the USA (this usually means making, providing, storing and/or transporting goods or services inside the USA), there will be no tax liability in the USA either, although you may end up owing taxes on the profits of the UK LP if you are a citizen or resident of the USA and depending upon how ownership was set-up.

There are many ways of setting up a UK LP depending upon the needs of the client. Let’s chat if you have any questions!

What is an LLC? Why should you care?

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A limited liability company (LLC) is a hybrid business entity that blends together characteristics of a partnership and a corporate structures. It is incredibly flexible giving limited liability to its Members (the owners) just like a corporation, but offering the ease of management of a partnership.

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It also can offer interesting tax advantages depending upon how you want to use it (but only if properly set-up). It can be set up to be treated as a “disregarded entity” providing “pass through” tax treatment, or it can be set up as a “taxable association” in which case it is taxed like a corporation, but without some of the negative aspects of a corporation. This can often avoid double taxation.

But the most interesting aspect of an LLC is its ability to protect your assets. How can an LLC protect your assets?

The LLC has many special features similar to a partnership that are very beneficial for asset protection:

  • A partial LLC interest, unlike shares in a corporation, cannot be easily seized by creditors. If a Creditor attempts to take your Membership Interest, the creditor will only receive an “assignment” of the interest. The creditor can take away your membership interest, but will not be able to vote in the absence of the unanimous approval of all the other Members.
  • An LLC can require Members to make additional contributions of capital. So if a creditor takes away your Membership Interest, the LLC may require the Creditor to make additional contributions to the LLC. If the Creditor refuses, he may lose his interest in the LLC.
  • If the LLC shows a profit, it is not necessary for the profit to be distributed to the Members but can be retained by the LLC. However, the Members will be taxed on this profit even though they did not receive it. So if a Creditor takes your Membership Interest, the LLC can operate at a profit, and may be able to force the Creditor to pay taxes on profits which the Creditor never received.

A creditor who attempts to take your shares in the LLC will only get an assignment of non-voting shares. The remaining shares will be held by the other members who may be friends, family, or even specially designed trust that will protect your interests. These other Members will be able to vote on who becomes Manager of the LLC, not the creditor that took an assignment of interest.

The other members may choose to appoint you or another friendly person to be the Manager of the LLC. As Manager of the LLC you will be able to decide whether or not you and other employees get a salary, whether or not assets are sold, whether or not profits are distributed, whether or not there is a need for additional contributions from the Members, etc.

In essence, a Creditor who takes your shares in a cleverly designed LLC will not be able to vote or control the company, will not be able to force distribution of assets or profits, may have to pay taxes on income earned by the company even though it never received the profits, and will be vulnerable to demands for additional capital.

As you can see this would be a very unpleasant situation to be in if you were a creditor, but a very good situation to be in if you are trying to protect your assets. Few creditors will want your membership interest in the LLC when they realize what a hornets nest they are getting themselves into.

I have designed a specific system to be able to take advantage of these attributes of an LLC. I call it The Personal Preservation Fortress®. Check it out if you would like to get more information on how to effectively and affordably protect your assets.