LLCs May Be Right Unless They’re Wrong

As I’ve posted before, I usually advise non-US companies to form a corporation when expanding to the United States. Every now and then, I get some pushback because the non-US company has heard about ‘limited liability companies’ (LLCs) in the US and wants to take advantage of the pass-through tax advantages of the LLC form. Before diving too deeply on this, let me get some definitional items out of the way. Corporate law in the US is predominately a creation of, and within the control of, the states. That’s why you hear about a ‘Delaware corporation’ or a ‘New York corporation’ and not a ‘United States corporation.’ That’s our Federal system at work (when it works). The corporation form in the US is similar to the limited company forms in Ireland and Northern Ireland, in that the shareholders/investors in each are only liable for the entity’s debts to the extent of their investment.

One challenge with the corporate form in the US is taxes: the US tax system imposes a tax on the revenues of the corporation and imposes a separate tax on a shareholder to the extent the shareholder gets a distribution/dividend from the corporation. Many years ago, the various states (led by Delaware if I remember correctly) created the LLC form that blends (i) the liability shield as to shareholders of the traditional corporation form; with (ii) taxation as a partnership. Under the US tax code, partnerships are considered disregarded entities (remember that term), and not taxed at the entity level. For partners in a partnership (and members of a LLC), that means a single level of taxation—no tax at the entity/company level on revenues but tax at the partner/member level on that partner/member’s ‘share’ of the entities profits. There is no question that the LLC form is much more tax efficient than the corporation form.

So, non-US companies, including Irish and Northern Irish companies, expanding to the US often start with the assumption that a LLC is the correct form for their US operations. The thinking—and it is compelling—is why use a form that has two levels of taxes rather than a form that has one level of taxation? The answer: the branch profits tax (remember that term, too).

For an Irish or Northern Irish company expanding to the US and planning minimal contacts in the US, a LLC would be a perfectly acceptable form. For example, an Irish company client is expanding to the US—solely by selling their product to a US distributor. They are not planning any additional ‘contacts’ with the US—just the sales. In that case, a LLC makes a lot of sense for the Irish parent. Another client, also an Irish company, is starting with sales but will also will hire employees, warehouse product in the US, and, in general, have more contacts with the US. In that latter case, the limited liability company form would not be the best option for US expansion, but the corporation form would be preferable (or to muddy things even more, a limited liability company that elects to be taxed as a corporation would be another option), because of the branch profits tax.

Under the various tax treaties the US has, including those with Ireland and the UK, the US business operations of the Irish or Northern Irish parent company are ‘protected’ from US tax so long as those operations don’t create a ‘permanent establishment’ as defined in the relevant treaty. Determining permanent establishment is a fact-intensive process, but the general rule of thumb is that the more contacts, the greater the likelihood of permanent establishment—and the contacts have to be in the US, such as opening an office (fixed place of business), operating a warehousing/fulfillment center, hiring employees, etc. Again, simple sales should not, by itself, give rise to a permanent establishment. But, the more contacts…..

Remember the term ‘disregarded entity’? Here’s how it plays out with the permanent establishment question. Under both the US-Ireland and the US-UK tax treaties, if an Irish or Northern Irish business is deemed to have a permanent establishment in the US, it means that their US operations are subject to US tax. If the Irish/NI company operates through a corporation (or a limited liability company that has elected to be taxed as a corporation), the responsibility for that tax is a simple question/answer: it’s on the US corporation. If the Irish/NI company operates through a limited liability company or other disregarded entity, it means that the Irish/NI parent has effectively connected earnings and profits in a trade or business branch in the US, and is subject to the branch profits tax.

The US branch profits tax is a tax on the repatriation of earnings, in the form of dividends, from a foreign parent’s US branch to the home office in the foreign country. This tax is imposed in addition to any income tax paid by a foreign corporation to the US IRS. And here’s the punchline: the branch profits tax operates as a 30% tax on the Irish/NI parent’s profits derived from the operation of businesses in the US—it is enforced as a 30% withholding tax on distributions made to the Irish/NI parent. By contrast, using a corporation form under the US-Ireland or the US-UK tax treaties the withholding rate on dividends ranges from 5% to 15%. So, that limited liability company form may not be the most efficient option after all.

To break it down even more:

  • If no permanent establishment, then LLC acceptable.
  • If permanent establishment likely/possible, then use corporation or LLC that elects to be taxed as a corporation.