M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

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Monday, July 2, 2012

Delaware tax haven?

What?  Was it a slow news week last week?  Nothing else newsworthy to write about? [jk] That can be the only explanation for this piece that appeared in this weekend's NYTimes, "How Delaware Thrives as a Tax Haven".   There are two issues pushed in the article: first, the "tax haven" thing.  Firms use Delaware corporations to avoid state, not Federal, tax liabilities on trademarks, patents, and investments.  Here's the strategy as they described in a 2009 NY Times piece ("Critics Call Delaware a Tax Haven"):

Corporations are allowed to establish these shell companies in Delaware, as well as in Nevada and Wyoming.

Typically, they then transfer to these subsidiaries ownership of things like trademarks, patents and investments. Delaware does not tax holding companies set up to own and collect income from such lucrative intangible assets.

The parent companies of these shells usually pay royalties to the Delaware subsidiaries to lease back those assets. By doing so, they can claim income tax deductions in states where they actually do business. The shells also funnel profit, tax free, back to their parents, in the form of dividends and loans.

OK.  So I guess one can get some tax savings at the state level by structuring this way.   But, is that news?  My guess is no. How can it be? The Times published a 2009 piece on the exact same subject.

In any event, the tax thing is just a set up for the second issue raised in the article, which is the more nefarious one...Delaware corporations are secretive, more secretive than Cayman corporations!

Big corporations, small-time businesses, rogues, scoundrels and worse — all have turned up at Delaware addresses in hopes of minimizing taxes, skirting regulations, plying friendly courts or, when needed, covering their tracks. Federal authorities worry that, in addition to the legitimate businesses flocking here, drug traffickers, embezzlers and money launderers are increasingly heading to Delaware, too. It’s easy to set up shell companies here, no questions asked. ...

What does it take to incorporate a company in Delaware? Not a lot, tax experts say. Shell companies — those with no employees, no assets and, in fact, no real business to speak of — are remarkably easy to establish here, and it doesn’t always matter who you are or what business you are in. Viktor Bout, the Russian arms dealer known as “the merchant of death,” used two Delaware addresses. In April he was sentenced to 25 years in prison on terrorism charges resulting from an American sting operation.

Did you know that if someone incorporates a business in Delaware, that no one, not even the state of Delaware knows who the beneficial owners are!  And that's the reason why Delaware is such a popular location for incorporations.  Wait ... what? 

Now, if Delaware were the only state in the U.S. to shield the identities of beneficial owners, I might be interested in the rest of what this article has to say.  But, let me just state as a matter of fact, most - if not all - states in the U.S. have the same basic rule with respect to beneficial ownership.  And that is, the identities of beneficial owners of corporations incorporated in the US states are not known to the state government by default.  Can you imagine what the paperwork burden would be on the state and start-ups if everytime an employee at a start-up was issued an immediately exercisable stock option the corporation had to make a report to the State?  Uh ... hellooo!  

It's really a non-starter of an idea and the resistance to the idea won't come primarily from Delaware, it'll come from California, home of most of America's start-ups.  Anyway, if you want to go after anyone for excessive privacy with respect to corporations, why not go after someone who really deserves it, like Nevada.  That was their schtick for a long time.  Not only do you not have to report the identities of your beneficial holders, you can report "nominee" directors and officers on your annual reports.  That's even more secret than Delaware!  

Michal Barzuza has a very good recent paper on Nevada as a "liability-free zone" for incorporations.  The Times should have started there rather recyle an old story in a "slow news week".

-bjmq

 

July 2, 2012 in Delaware | Permalink | Comments (1) | TrackBack (0)