Delaware Deep-Dive: The World’s Biggest Offshore Jurisdiction
The word “offshore” conjures up images of pristine tropical islands with coconut trees and rows of PO boxes on a sandy beach. However, the world’s largest offshore jurisdiction looks nothing like that. Think of leafy roads, red-brick townhouses, and the unmistakable charm of small-town America. Welcome to Wilmington, Delaware.
It might come as a surprise for some, but the United States, by every possible metric, is the largest offshore jurisdiction in the world. People in the US sometimes find this hard to imagine: For Americans, doing business at home comes with high administrative burdens, a web of complicated regulations, and a constant fear of the mighty IRS. For foreigners, however, America is rolling out the red carpet. Company owners and founders with no ties to the United States often find the best conditions in Delaware, Wyoming, Nevada, and to a lesser extent, in Florida and Texas.
Why the United States?
The US is the most popular offshore jurisdiction for three main reasons: the lack of reciprocity in reporting, the laissez-faire approach of some of the states, and the importance of the US Dollar and the American banking system.
No automatic exchange of information
The United States is the world’s most important economy, and not even a bit shy to use this privileged position to its advantage. Nowhere is this more apparent than in the lack of reciprocity in reporting. Uncle Sam wants to know everything about what his taxpayers do abroad, and every single bank in the world has to report back on American citizens: bank account numbers, balances, everything. Any bank not complying with this regulation, FATCA, is subject to enormous fines and under the risk of being expelled from the global banking system. The US, on the other hand, is silent as a sphinx.
After decades of talks, the OECD introduced the Common Reporting Standard in 2017. It is an international system to report on offshore activity and tax evasion practices. Virtually every developed country signed up to it. Today, 102 nations already share financial information, and 54 developing nations are in the process of implementing it, from Liechtenstein and Monaco to Eswatini and Mauritania. There is one country missing from the list: the United States.
The Financial Secrecy Index from the Tax Justice Network ranks the US #2 in the world, just behind Switzerland and ahead of well-known tax havens like the Cayman Islands, the British Virgin Islands or Jersey.
State-level company formation laws
The US also offers robust privacy and legal protections at the state level. The Wild West Don’t-Thread-On-Me ethos is still very much alive in America, especially in places like Wyoming and Nevada — but also in Delaware. Incorporating a company does not require any KYC, and shareholder information is not public in many states. The US is a leading jurisdiction for asset protection as well.
Sitting right at the USD switchboard
Lastly, the US sits right in the middle of the web of global banking. The US Dollar is (still) the world reserve currency, and most of the international transactions are cleared in USD. American banks can be bureaucratic, but the benefits of USD banking and the infrastructure in place, from payment processors to brokerages and exchanges, outweigh the occasional clunkiness of their online interface or the outmoded decor of many of their branches. They might not be the absolute best (banking in Hong Kong and Canada is typically better), but anyone who has ever tried running an offshore business with a bank account in the Caribbean surely appreciates the US banking system.
Delaware: from obscurity to company hub
Delaware is an unlikely candidate for the largest offshore jurisdiction in the world. It might have been one of the very first places colonized by the Europeans, but it never had the glitz and glamour of New York, the charm of New England, or the pioneering spirit of the Pacific Coast. It was, by all means, a sleepy little state without anything remarkable to offer. But in 1899, this all changed.
It was the year when Delaware enacted its corporate statute, the second in the country. New Jersey was the first, three years earlier, but that law was temporarily repelled in 1913. For a few short years, Delaware offered the best conditions to incorporate a company in the United States (for Americans; offshore as an industry barely existed at this point), and this triggered an exodus of companies that wanted to be incorporated there.
Delaware has been the leading corporate state since the 1920s, and its position has been unchallenged. Today, more than 60% of the Fortune 500 companies are incorporated in Delaware, not just because of the favorable tax conditions, but also because of the unparalleled body of corporate case law spanning 120 years. There is a precedent for virtually any legal question, and Delaware even has a unique court system specifically for business cases wit its sophisticated Court of Chancery.
As a result, today Delaware has the largest concentration of companies in the world with around half a million companies formed there every year.
Why the US is a good place if you are not from the US
The benefits the United States offers for non-resident company owners lie primarily in the absence of automatic exchange of information if you hold a bank account as a non-resident, and — in the case of a non-resident owner of a US Limited Liability Company (LLC) — in non-US income of the LLC falling outside of the US tax web.
For example, a Norwegian owner of a Delaware LLC who sells dietary supplements online and derives most of its income from non-US clients will not be taxed in the US on its sales abroad. This puts the LLC for non-residents at a par with the Canadian LLP (in British Columbia) or the UK LLP, but comes with the added benefit that the LLC will benefit from all the infrastructure of the US (such as a USD bank account, easy software subscriptions, payout modules, Apple App Store and Google Play accounts). Online solutions can all be subscribed for in name of the LLC and paid for in USD.
For all this to work, one needs to pass the “non-resident alien” test. Such non-resident alien is someone who is not a citizen or permanent resident (i.e. Greencard holder) of the US, and who does not meet the substantial presence test. In practice, this means you should count the number of days you spend on American soil. In true IRS fashion, the calculation is anything but straightforward.
To meet the substantial presence test, you must be physically present in the United States on at least:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:
- All the days you were present in the current year, and
- 1/3 of the days you were present in the first year before the current year, and
- 1/6 of the days you were present in the second year before the current year.
If you satisfy these conditions, you are a resident alien from a taxation perspective, and you will not be able to enjoy most of the above benefits.
Delaware LLC vs C-Corp
It is essential to understand the difference between the two main different company types Delaware offers: LLCs and C-Corporations. At Otonomos our company formation services currently include both, and we are working on a “blockchain-native” LLC incorporation product — more on that later.
Legally speaking, LLCs are akin to partnerships where the Partners are called Members, whilst C-Corps are corporations and its owners are stockholders or shareholders. They share some common characteristics:
- They both offer limited liability protection. Company owners and managers are not personally liable for the company’s obligations.
- They both offer protection for intellectual property.
- They both can have an unlimited number of owners or as few as one.
There are also significant differences:
Structure
An LLC is extremely flexible. The Operating Agreement does not have to follow any established standards, and members are free to agree on any structure they see appropriate.
A C-Corp is much more structured utilizing clear, well-understood concepts like stocks representing ownership, a board of elected directors, company officers, etc. and a significant body of best practices has grown around its setup.
Privacy
Members of an LLC are not listed in the company records, and they can remain completely anonymous.
Shareholders of a C-Corp can also stay private, but the name of the elected officials and the members of the Board have to be public. Some companies mitigate this issue by employing nominee managers and board members, which is entirely legal.
Taxation
Most crucially, LLCs and C-Corporations fall under very different taxation rules.
An LLC is a pass-through entity, and it does not need to pay corporate tax (other than an annual registration fee to the State registry which varies from State to State). Any profit the company generates gets taxed at the level of the individual owners. If those owners live in a low tax country, tax on their LLC income will be highly optimized. An LLC can also be owned by any entity including foreign entities. If such entities are based in a offshore jurisdiction e.g. Cayman Islands, there will be no tax due on LLC profits at the Cayman level.
A C-Corp, on the other hand, has to pay corporate taxes, and shareholders are personally taxed as well on any income they generate from the company (dividends, capital income, et cetera). Getting taxed twice certainly doesn’t sound as good as pass-through taxation. However, the C-Corp has other benefits for different use cases, mainly when it comes to fundraising.
Fundraising
The ease of fundraising is the main reason most founders opt for a C-Corp. An LLC is a partnership: there are no “shares” or “stock.” The Operating Agreement can set up legal structures similar to these concepts, but some features are very hard to emulate, like options, share dilution, et cetera.
As a general rule, almost all outside investors and US venture firms will require you to set up as a C-Corp, or convert your LLC into a C-Corp, when raising money from US investors. Non-US investors should also get comfort from being part of a C-Corp if funds are raised from both the US and outside the US.
In summary, LLCs and C-Corps are different structures, even if they share some common characteristics. There is no one-size-fits-all approach: an LLC might be more suitable for a solopreneur or a small group of founders who do not seek outside funding, while a C-Corp is more “future-proof” and enables exponential growth.
Do you really need a C-Corp?
There is a lot more involved with establishing, and especially maintaining a C-Corp than an LLC. There are also administrative burdens and severe fines for missing a filing or making a mistake in the books. Yet, as indicated above, you most likely will need a C-Corp if you wish to raise money from venture capital funds in the US and are planning to operate in the US.
An LLC, on the other hand, could be a suitable operating entity for solopreneurs or owners who work from outside the US and whose operations are largely outside the US. The LLC could also be a good entity for a blockchain project raising funds from the community through an ICO/IEO, if it looks to also raise from US investors under US securities laws.
Setting up a Delaware C-Corp or an LLC
Costs of a Delaware C-Corp
Setting up a Delaware C-Corp only takes 24–48 hours, and it is inexpensive compared to competing jurisdictions:
- Our $249 instant incorporation pack includes name check and application, template bylaws, document filing with the Secretary of State, free statement of the incorporator, online access to your incorporation documents, and initial capital structure and share issuance.
- Companies need to pay a state tax of $90. This fee goes directly to the Secretary of State and represents what Delaware charges to incorporate a new business.
- Each Delaware corporation has to appoint a registered agent with a physical address in the State of Delaware. Otonomos itself will be your registered agent for just $218 per year, which includes filing of your company’s Annual Return and a standard registered address for your business.
We also set up an end-to-end encrypted Tresorit™ folder where you can share sensitive documents and information with us. This service costs $240 annually.
With a one-time payment of $795 and an annual maintenance fee of $458, Delaware is one of the most affordable options to have a recognized, credible US entity iff you plan to setup shop in the US and raise money there.
Incorporating a Delaware or Wyoming LLC
We can also help with the setup of your LLC in either Delaware or Wyoming. The setup is fairly similar, although Wyoming is slightly cheaper on the annual Registration fee.
We also like Wyoming for its blockchain friendliness, and a fair number of our clients use it as a cheap and cheerful solution to wrap limited liability around a trademark, IP or even smart contract. Wyoming is also a very good place for an US operating entity for non-US owners, as it is extremely light on maintenance.
For both the C-Corp and the LLC we can also help you set up a bank account in the United States (a visit in person is required), open a KYC’d crypto exchange account, or appoint nominees. See our Delaware product page for a full list of services.
Besides credit/debit cards and AliPay, we also accept all major cryptocurrencies as a payment method (BTC, BCH, DAI, ETH, XMR, and ZCASH etc).
Undecided? Book a free, 20 minutes consultation to find out if Delaware is indeed the best option for your business!
One more thing…
Finally, for those blockchainers among you, we are soon to announce the launch of a bleeding-edge product that will allow you to spin up a Delaware LLC in 5 seconds for the price of a cup of coffee. It is the result of months of legal and technology engineering to compress the time and cost of LLC formation using smart contracts. You can get a glimpse of how this will work here otoco.io and test it on Ropsten.
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Originally published at https://otonomos.com on November 25, 2019.
