ESTABLISHING A BUSINESS IN THE US

1. ESTABLISHING A BUSINESS IN THE US Zara Law Offices 111 John Street Suite 510 New York, NY 10038 Tel: 1-212-619 45 00 Fax: 1-212-619 45 20 www.zaralawny.com

2. Introduction • The recent weakness of the US Dollar may present foreign companies with the best opportunity in years to invest in the United States. • We have prepared this short guide to highlight some of the most important issues that foreign companies face when establishing a new business in the United States.

3. Establishing a Business in the US: the Planning Stage

4. Establishing a Business in the US: the Planning Stage The most important initial considerations and preparations before forming a new business in the US: • Which type of entity best suits your needs and where to register that entity • Depending on the type of entity, the applicable tax implications, both corporate and personal • Name of the new entity • Analysis of the costs involved • Immigration and visa requirements for the individuals involved in the business • Drafting a good business plan • Finding and renting office space; obtaining phone and Internet access, advertising and developing a website; registering a domain name • Hiring an accountant • Opening a bank account and deposit of funds for initial expenses.

5. How to do business in the US • You may register your foreign company in the US as a foreign entity authorized to do business here Advantages: 1. Convenient with respect to bookkeeping, audits, etc. 2. All income and expense accounts will be at the same location Disadvantages: 1. US Tax System 2. Liability exposure of your foreign company • In most instances, the better option is to form and register a new entity under US law

6. US Tax System

7. US Tax System - Income effectively connected with a US Trade or Business • If you choose to register your foreign company in the US, you are generally obligated to pay US taxes only on “income effectively connected with a US Trade or Business.” • However, the interpretation of whether a foreign entity’s income is effectively connected with a US trade or business is quite broad. The Federal tax authorities in the US (called Internal Revenue Service) may include such business activities that are only marginally connected to “US trade or business.” In other words, may be taxed in the US on your foreign company’s income even the income is only slightly related to your US business.”

8. Other Tax Considerations – The importance of hiring a good Accountant • The US tax system is complex. Your entity will require the services of a good accountant, fully versed in all the applicable tax laws and their ramifications. • While the US is often regarded as a country with low taxes, bear in mind that taxes are not only imposed by the Federal government, but also at the state and local government level. Moreover, companies are liable not only for income tax, but also for other types of taxes (e.g. capital gains tax, real property taxes). • In general, US companies are taxed on their world-wide income, but to avoid double taxation, tax treaties exist between the US and a number of countries.

9. Liability • If the foreign entity you registered in the US gets sued in the US, its assets overseas may be at risk in the lawsuit. • However, if you establish a new entity in the US, a plaintiff may sue only the US entity and collect only on its assets. • To reduce your litigation risk, it is therefore advisable to conduct your activities in the US through a newly formed US entity. • However, bear in mind that if you establish a company in the US and start business activities without sufficient capital, or if you fail to keep proper business records, the shareholders, owners, etc. of your US company may be personally liable for the company’s debts (the underlying legal concept is often referred to as “Piercing the corporate veil”). This includes the foreign company if is one of the owners of the US business entity.

10. Main entities available under US Law* • The establishment of business entities is governed by the applicable laws of the state in which an entity is formed. Depending on the type of entity, differences in filing requirements, tax treatment for state taxes, etc. may exist from state to state. • Limited Liability Company • Corporation • Partnership * Please see our Guide on “Creating a Commercial Entity in New York” for details on the features of each type of entities and the specific filing requirements under New York law.

11. Limited Liability Company (LLC) • This is the entity that we most often recommend for foreign clients that want to form a company in the US. • The owners of an LLC, called “members” are generally shielded from liability for the company’s debts. Only the members’ capital contribution to the LLC can be used for the company’s liabilities. Unless the members personally guarantee the LLC’s debts, they will not be liable with their personal assets. • A significant feature of the LLC is the single level of taxation (as opposed to a corporation): The income of the LLC is not taxed, but instead each member of the LLC is taxed based on his or her pro rata allocable portion of the LLC's taxable income, determined by the member’s membership interest. Conversely, if certain circumstances are met, the members may deduct the LLC’s losses on their personal tax returns.

12. Limited Liability Company (LLC) - 2 • Members of an LLC are not required to be American citizens or permanent residents (i.e. green card holders). • Foreign nationals who are not US residents and do not have a US Social Security Number must obtain an Individual Taxpayer Identification Number from the US tax authorities so that they can file US Tax Returns. • Unless they have obtained a proper visa as well as a work permit, foreign nationals are not allowed to work for the company (this includes members of an LLC). • In a number of states, an LLC cannot be formed to conduct certain types of businesses (e.g. banking, insurance). • In addition, when the rendering of certain professional services is involved for which state laws usually prescribe licenses (e.g. medicine, engineering, legal services), the formation of a Professional Limited Liability Company is required. This generally means that the members of the Professional Limited Liability Company have to be licensed in that profession.

13. Corporation • Subject to double taxation: • Gross Profit minus Necessary and Reasonable expenses = Taxable Net Profit. Every corporation is subject to this first degree of taxation. • The secondary level of taxation is the tax collected from the salaries and bonuses paid to the shareholders, board members, and employees. • A corporation may avoid double taxation by electing to be taxed as a Partnership under Subchapter S of the Internal Revenue Code. An entity treated this way for tax purposes is commonly referred to as “S-Corporation.” • However, there are certain requirements to qualify as an S-Corporation; for example, all of the shareholders have to be US citizens or permanent residents.

14. General Partnership • AGeneral Partnershipis made up of two (2) or more individuals who contribute assets or services to a commonly–owned business, act with full personal liability and share the profits and losses of the business. • The profits or losses of a General Partnership are passed on to the General Partners without taxation at the General Partnership level. Moreover, under certain circumstances, some general partners can deduct from their personal income tax returns, their share of the business losses of theirGeneral Partnership. • AGeneral Partnership does not have the formal organizational hierarchy of a Corporation, and all general partners are entitled to a share in the management of the Partnership. Each of them is authorized to contractually bind the General Partnership.

15. Limited Partnership (LP) • Two (2) kinds of partners exist: Limited Partners and General Partners. • A Limited Partner is only liable for the LP’s debt to the extent of his or her capital contribution. • A General Partner has unlimited liability: He or she is liable for the LP’s debts not only to the extent of his contribution, but also with his or her personal assets. • Limited Partners may only contribute money or other property to the LP. They may not contribute services, or do work for the LP. If a Limited Partner performs work for the LP, the LP’s creditors may be able to argue that such partner should be deemed a General Partner, and therefore be fully liable for the LP’s debts.

16. Joint Ventures (Business partnerships) • A Joint Venture is a contractual agreement joining together two (2) or more parties for the purposes of executing a particular business undertaking. All parties agree to share in the profits and losses of the enterprise. • Like the Partnership, Joint Ventures can involve any type of business. • A Joint Venture has most of the elements of a Partnership such as shared management, the power of each member of the venture to bind the others in the business, division of profits, and joint responsibilities for losses. However, unlike a Partnership, a Joint Venture anticipates a specific area of activity and/or period of operation, so that after the purpose is completed, bills are paid, profits (or losses) are divided, the Joint Venture is terminated. • A Joint Venture may be formed as “C corporation (corporation)”, a “partnership” or a different legal structure. When choosing the type of entity, it is advisable to focus on taxation and liability issues.

17. Written Agreements • Never sell your products in the US without a well-drafted sales agreement • Secure your transactions with your customers (e.g. security agreement, personal guaranty) Please see our Guide on “Managing Export Risk” for more details on these and on other related matters.

18. Hiring Staff

19. Hiring Staff • Unless there is a particular employment contract, employees in the US are deemed to be "at will“, which essentially means that they may quit or be fired at any time without notice and/or without particular cause. • There are, however, various federal, state, and local laws that you will have to comply with as an employer, ranging for example, from minimum wage to workplace safety laws. • Be aware that the US has specific laws prohibiting discrimination, and you may not ask an employee, during the interview and at any other time, about their age, marital status, sexual preference, religious affiliation and certain other personal information.

20. Hiring Staff - 2 • If you want to bind your employee to your company for a certain amount of time. • If there is confidential information about your company that you want to protect. • If you want to prevent your employee from working for any of your competitors in the future. Situations where you should have a written agreement with an employee:

21. Employee & Independent Contractor distinction • For tax as well as other reasons, the distinction between an “employee” and an “independent contractor” is a critical one. • If you hire a person for a specific project, and the person is not under your control, and performs the project on his or her own, that person is generally deemed to be an independent contractor. • If you hire somebody to perform general duties in your company and you supervise or manage the job he or she is doing, this person is usually considered your employee.

22. Employee & Independent Contractor distinction - 2 • Employers pay their employees’ taxes by deducting the amount from their salaries. • If you hire an independent contractor, that individual pays his or her own taxes. • This factor alone should not determine whether you hire an employee or an independent contractor. • Generally, the more control over the worker you have, the more likely it is that he or she will be considered your employee. • The IRS uses its own criteria to determine who is an employee and who is an independent contractor.

23. The criteria used by the IRS in determining the Worker/Subcontractor distinction • Whether there is a written agreement between the parties and the terms thereof. • Whether the employer has the authority to direct the person how to do the job, and to check on his or her work. • Who owns the tools and equipment the worker uses to do the job. • Whether or not benefits such as health insurance are given to the worker. • Whether the employer pays the worker’s business expenses.

24. Renting office space

25. Renting office space • It is generally not advisable to use your home as your office since: • It may leave an unprofessional impression on clients/customers. • It may not be possible to deduct the rent for your home as office rent expense. • If you do use your home as an office, you may only deduct from your taxes that portion of the rent proportionate to the room that you use as an office. • When calculating the rent of the room, the length of the daily occupancy of the room as an office will be considered, and the tax authorities may also investigate whether you also use the room for living, etc. • In contrast, the rent for a separate space leased as an office is fully deductible from your business taxes.

26. Renting Office Space -2 • It is a good idea to have a lawyer review your lease before you sign it. • Keep in mind that lease agreements are usually drafted by landlords’ attorneys to serve their interests, and your lawyer may be able to negotiate better terms than you can on your own.

27. Conclusion • Unless there is a good reason to use your foreign entity in the US, for liability and tax reasons, it is usually preferable to form an entity under US laws. • Never sign anything that you do not fully understand, e. g. a lease, agreement with a supplier or any corporate document, without having the document first reviewed by a lawyer. • Insist that all agreements with suppliers, buyers and others be in writing. • Unless you receive payment in advance from your buyers, obtain security agreements that give you a security interest over the goods you sell, and/or request third-party guaranties. • Prepare a good business plan, including marketing information. Since you might have to present the business plan to banks and/or potential investors, it is better to have it prepared by a professional. • Good luck!