The tax part is pretty inaccurate. If you use business IP and transfer it to Delaware you will not avoid California tax on income from that IP. The unitary business and formulary apportionment approach of California income tax (also the dominant approach of multistate income tax in other states) easily beats that strategy, by treating formally separate entities as one for taxation. The sort of income shifting described in the article works better in international taxation since there the dominant approach is a āseparate accountingā aka separate entity approach.
Indeed, even the Geoffrey case the article notes is famous for Geoffrey losing in South Carolina, and having its income taxed in that state.
Nonbusiness income is taxed to commercial domicile, which does promote moving headquarters to a tax haven. But much less income is considered nonbusiness income than youād expect, and further commercial domicile is a separate concept from place of incorporation.
By far the dominant reason for Delaware as a corporate place of incorporation is its well developed corporate law and courts. It is more favorable to corporations in part, but not excessively soāVCs would not be pressuring corporations to incorporate in Delaware if it purely screwed shareholders at the corporationās benefit.
There are also estate planning and asset protection benefits of using Delaware (and certain other states) LLCs.
> well developed corporate law and courts
To put this into context, the average time in 2020 for a civil case to go from filing all the way to an appeal to the Delaware Supreme Court was 185.8 days; from submission to the Supreme Court, 32.8 days [1].
Californiaās courts donāt publish this information regularly, but the last time I checked, the comparable statistics were 3 years and one year.
[1] https://courts.delaware.gov/aoc/annualreports/fy20/doc/2020S... page 8
Exactly right. I'm a Delawarean, and in my former career as a journalist I wrote about this phenomenon. It's all about the courts. It is a risk mitigation strategy for businesses. Having extensive, well-defined case law makes things more predictable.
One of the peculiarities of the US is how you guys managed to effectively bootstrap industrial districts at continental level for the weirdest meta-stuff, from newspapers to movies to corporate accounting.
When it comes to running a business in the US, itās almost better to think about each state as if it were its own country because youāre subject to a substantial amount of state laws. You canāt incorporate at a federal levelāonly state level.
Federal law does it exist, but it feels like more a set of minimal standards. Most of the differences that people pay attention to are state laws because they usually go above the federal laws and regulations.
Funny enough, it's a rather common trope in fiction, which loves to stereotype people into stratums by any imaginable criteria. IIRC blog posts were pointing out the geographical specialization in Hunger Games and saying that it's pretty ridiculous because not fault-tolerant. Basically, if California were to break off and fall into the ocean, a huge chunk of US tech and entertainment sectors would disappear.
Newspapers? I would have said those were pretty distributed. Yes, a couple of the big national ones are in NYC, but that's where the population is. Finance is certainly another example. Obviously at least a certain subset of tech. Oil.
Is this really that unusual though? And, to the degree it is, how many other large countries have the same sort of distributed large population centers?
> how you guys managed to effectively bootstrap industrial districts at continental level for the weirdest meta-stuff, from newspapers to movies to corporate accounting
This is a common market flexing its economies of scale. India and China do similarly. If the EU could get its act together, it, too, would reap these benefits.
Check out parentās profile. Wish these books were around when my kids were young
Wyoming has had a Court of Chancery for several years now too
They and any state could always lean on Delaware case law
And if you don't like Delaware established precedent then you can argue for the opposite in any other state (like Wyoming) where the judges are less bound to the established case law
Delaware is overrated
The race to the bottom never ended and is much larger than a collection of states, it is international with many permutations and many legislatures interested in attracting business, because they're a business too
> And if you don't like Delaware established precedent then you can argue for the opposite in any other state (like Wyoming) where the judges are less bound to the established case law
That's the opposite of what you want.
I have no legal background, so I could be wrong, but I would think that in both DE and WY the established precedent is overturnable, given the strength of your argument. If that's so, then it seems like the preference for WY is that you don't need as solid an argument.
But rarely do businesses know which precedents they'll want to challenge at incorporation time, so it's advantageous to go with the state that is the most predictable and whose court system is relatively efficient.
Yup, this article falls squarely in the "misinformation" category, and the author has no experience with tax law, nor does he cite any authorities to support the tax avoidance thesis. He's just winging it, improvising, about corporate tax law. It's crazy how low journalistic standards have fallen as the line between news article and "personal blog" has been blurred.
I am not ascribing ill motive to the author. Just incompetence in trying to write about a very complex topic that is far out of his depth, and doesn't allow for simple moralistic summaries like "Big biz not paying their fair share!".
I don't disagree, but the website URL is called "the hustle".
I don't think it would be far fetched to think that the content should be viewed with a healthy dose of skepticism ?
It is actually simpler than this, and that is it is extremely difficult to pierce the corporate veil in Delaware. It is considered one of the strongest states for segregating the officers and shareholders except in cases of outright fraud.
We are a pretty normal delaware c corp . If optimizing for not paying taxes, we'd probably focus on states like Texas, and divest from anyone and anything in California, but we haven't.
Bigger than our taxbill is our accountant, lawyer, etc bills, and in turn, their jobs get easier with delaware: they know it & it doesn't change as much as say California. More than taxes is day to day like big multiparty contracts , equity management, and more existentially, potential m&a. delaware law isn't federal law, but everyone knows it and follows it, so close enough.
it might feel expensive to start and maintain, but probably isn't when you look back at your actual costs. in addition, legal counsel will pressure you to reincorporate if you don't, which would be a double cost. would be my default choice if doing it again: only want to innovate in so many things, and unlikely for this to be one of the most important areas of the business to be extra clever on.
Also, since the Wayfair decision, pretty much any interstate income is taxable where the customer is located if you do enough business in that state (usually an income threshold, but in many states its a number-of-transactions threshold).
Locating in Delaware literally saves you nothing in paying taxes; indeed, it actually costs a tiny bit more, tax-wise, than locating in your primary state of business.
But on the note of other compliance expenses: being incorporated in Delaware increases your compliance costs. You're now subject to suit in Delaware and whatever states you actually do business in (including especially whatever state your HQ is located in). So, for example, you don't avoid exposure to CA law if you have CA customers (and many state consumer protection rights can't be waived by a ToS or by a signed contract). And you don't need to be incorporated in Delaware to include a jurisdiction clause in your B2B contracts.
Delaware is useful in the limited situation that you are a corporation with a complicated capital structure that needs a management-friendly, shareholder-averse court system.
This is a good overview.
I honestly don't understand how these IP transfers are legal and continue to be legal. In the example from this article if the Delaware subsidiary bought the tennis balls from Vietnam for $10m and sold them to the California subsidiary for $80m, this is actually illegal. It's called transfer (mis)pricing. The general principle is that such pricing should be at arm's length. But for some reason it's totally fine for IP.
Not only does this avoid state taxes but it is the basis for big tech companies dodging federal taxes by transferring their IP to Irish subsidiaries and then paying "royalties".
So I'm a big fan of two reforms:
1. Profit apportionment. If 20% of your revenue comes from a particular state or country, that jurisdiction gets to tax 20% of your profit. This whole transfer pricing nonsense has to end and it's the real cause of the race to the bottom; and
2. Much higher property taxes for real estate owned by corporations rather than individuals. Corporate anonymity with real estate is a real scourge and drives speculative bubbles, money laundering and simply parking money in real estate, none of which does anyone any good.
2. I would suggest to have the same tax for everyone, but make it (and rent) deductable to a certain degree, if it is for your primary residence .
Ideally, it should be net-zero for people living there.
So real estate has a number of problems:
1. It's clearly used for money laundering and hiding money from hostile governments. In Europe, this is a huge factor in the London real estate market.
2. Cities die when people can't afford to live in them. This is exacerbated by restricting supply to simply park money. Often the ultra-wealthy buy a place where they'll spend 3 days a year because they like that place (eg NYC). In doing so, they're contributing to making that place worse. This behaviour should have a cost;
3. There are cities around the world that have pockets that are essentially vacant because of (2). Condos in Manhattan have a notoriously low occupancy rate. I've heard Tel Aviv has this issue as well. There are many others;
4. In many places it's more profitable tp produce (unoccupied) ultra-luxury property. A lot of the building in NYC is north of $4000/square foot. That's... insane.
5. Property taxes in NYC, as one example, are highly regressive. a $1m condo may have property tax of $1200/month. A $100m apartment may only incur $16k/month in property tax. The counterargument is that the more expensive apartment uses just as many services. Personally I think subsidizing ultra-luxury property is just bad.
Some jurisdictions (eg Vancouver) have tried to punitively tax "non-working" real estate, which is to say real estate that sits vacant. I don't think this has had much impact and it's probably really easy to game (eg rent it out to a family member notionally).
My philosophy is that:
1. Ultra-luxury properties are generally speaking bad for a city. They take up a disproportionate amount of space and tend to add nothing to the city. It's fine that they exist but we shouldn't be subsidizing their construction and continued existence;
2. Providing rental units for people who live in the city is a better use of capital than parking foreign money. As such, both parking money and foreign investment should be taxed at a higher rate. Local landlords are better than remote landlords (since those local landlords are part of the city).
Personally I think that if you own property in NYC, for example, then the state and city of New York gets to tax your income as if you were a resident. LLCs to hold property are the obvious dodge so these need to be taxed punitively.
People are waking up to this slowly. Globalization of capital is destroying the ability of local populations to purchase real estate in the places they themselves live. Multiple cities in Europe, even outside of London, are suffering from extreme Airbnbnization, where buildings are pricing out locals just because it's 3x to 10x more profitable to build them for airbnbs.
My philosophy is, whatever is bad, make people pay so much for it, that it will be (net-)positive. If they still do it, what's the problem?
> 1. Ultra-luxury properties are generally speaking bad for a city. They take up a disproportionate amount of space and tend to add nothing to the city. It's fine that they exist but we shouldn't be subsidizing their construction and continued existence;
I am not so sure about the first part, but I agree with the second. The proposal I made would in fact be a slightly progressive tax. I have no problem someone buys a $10million apartment in NYC and keeps it for a holiday in a year, if it say, costs $1 million in taxes per year and pays for a lot of other apartments, public transit, etc...
> 2. Providing rental units for people who live in the city is a better use of capital than parking foreign money. As such, both parking money and foreign investment should be taxed at a higher rate. Local landlords are better than remote landlords (since those local landlords are part of the city).
I have to disagree here. On two counts.
First, parking foreign money can be utilised to provide rental units who live in the city. We "only" have to frame the laws and tax code accordingly, and who cares then, what nationality the money has.
I also have to disagree on the assertion that local landlords are better than remote ones. Local ones may care for the city, or they care more about earning more money, and know all the tricks in the book. Remote ones may not care much about the city, but they also may simply have no idea of the local market, and do not want any trouble. You may guess, how my experiences were in that regard.
I think, we should not tax/punish people based on our prejudice we may have on them, but formulate a tax code, which punishes "bad behaviour" regardless of the nationality of the actor.
1) How does this get enforced? What stops Ireland, Camans, Monaco, or Luxembourg (note: I am not familiar with the most popular tax havens) from continuing to have low corporate tax rates?
2) How to prevent corporations from paying individuals/employees to manage property? Or giving them a cut?
> 2) How to prevent corporations from paying individuals/employees to manage property?
How should managing the property make them tax exempt? Do they transfer the ownership?
Let's say that BigCo wants to buy a $50M office building on the outskirts of the capital city of Taxis, where corporate owners of real estate are taxed at 8% of the market value of the property each year but individual owners are taxed at 1% per year.
BigCo writes a contract with Jane Schmidt, a citizen of Taxis. BigCo will loan Jane $50M to buy an office building, and Jane will lease the building only to BigCo. At the end of thirty years, Jane will have paid back the loan via the payments that BigCo has made, including necessary maintenance (handled by a BigCo subsidiary) and insurance (handled by BigCo's main insurance company). BigCo will also pay all reasonable and actual legal fees arising from Jane's ownership of the building. The contract provides that at any three year boundary or in the event of Jane's death, BigCo can direct Jane or her estate to sell the building to an entity of BigCo's choosing; Jane will get a fee but owe the remainder of the sale price to BigCo.
Jane is happy because she makes some money for the next three to thirty years. BigCo gets to avoid 7/8ths of the tax burden in exchange for a much smaller sum going to Jane. BigCo doesn't show the building as an asset but as a rent expense plus an income-generating loan.
At the end of the contract, BigCo directs Jane to sell the office building to Steve Jones for the current market price of the building, Steve having a similar deal in place with another company.
> What stops [tax havens] from continuing to have low corporate tax rates?
Nothing. But if Apple has $100B (out of $300B), as an example, in revenue in the US then the US gets to tax 1/3 of their income. If other countries decline to do likewise, well that's their choice. But tax havens are a scourge.
We've gone full Ayn Rand here where the people whose wealth was made possible by the stability and infrastructure in the countries they made that wealth in want to avoid at all costs paying for that stability and infrastructure. It's ludicrous and unsustainable.
Eliminating transfer pricing (both IP and non-IP) is a way of avoiding this race to the bottom as globally mobile capital perpetually moves chasing the lowest tax rates and short-term incentives.
> But if Apple has $100B (out of $300B), as an example, in revenue in the US then the US gets to tax 1/3 of their income.
That is already happening.
> Profit apportionment. If 20% of your revenue comes from a particular state or country, that jurisdiction gets to tax 20% of your profit.
There's already a local tax on revenue. Sales tax.
Sales tax isnāt collected on components of products. So an apple farm sells apples to a factory without any sales tax etc.
Taxing on point of sale is very useful if you want to capture externalities, but itās got minimal effect on the supply chain.
How is that relevant here? The notional problem consists of Apple Inc. selling an iPhone and then paying a royalty on the trade dress to Delawapple Inc. There is no supply chain involved, so it doesn't matter if the supply chain is unaffected.
The proposal above is that California should get to assess taxes against Apple based on Apple's revenue from California. And they do. That's what a sales tax is.
Sales tax is not a tax on revenue, its a tax on purchases (paid by the purchaser). Perhaps you are saying business taxes should be non-existent, but in most places they do exist.
Also, dont confuse revenue and profit. While some locales do have a gross receipts tax, taxing profits is much more common. This, in theory, incentivizes companies to pay out their revenues in the form of wages, R&D, building things, etc.
The tax strategy in the article (aka the "Delaware Loophole") doesn't actually work to avoid state taxes. In fact, the "Delaware Loophole" as it was called has not worked in most states for decades. (As another commenter noted: the sole example given of this loophole was a miserable failure. The Toys R US group ultimately ended up owing more money to South Carolina after its maneuver than it did before. https://casetext.com/case/geoffrey-inc-v-south-carolina-tax-.... )
Two reasons the "Delaware Loophole" doesn't work:
1) In most states, related companies are treated as a unitary group for tax purposes. (See for example, California.) This means that generally, intercompany transactions between the related companies are treated as not existing for tax purposes.
2) In states which don't have unitary group methods, they simply tax the IP lease itself on nexus grounds, as South Carolina did in the Toys R Us/Geoffrey case (Geoffrey LLC was a subsidiary of TRU that existed solely to lease the TRU IP). TRU's IP-expense deduction in South Carolina ended up being fairly small, after taking into account their low profits, so SC simply granted the deduction to TRU...and decided to tax Geoffrey on the IP lease on nexus grounds. Unfortunately for the subsidiary, they had no expenses apportionable to South Carolina (which is usually the case for IP holding companies), and so all of the lease was taxable in South Carolina. The TRU group ended up paying significantly more in taxes to South Carolina after attempting the Delaware loophole than it did doing things the honest way. (And this result was predictable from the very beginning based on the nexus laws even as they were back then, which is why companies don't do this within the U.S.)
Edit:
On your proposal #1: this is how income taxation generally works in the U.S. States already get to tax a company's income earned in the state, so long as (a) the company has a physical presence in the state or (b) isn't physically located in the state but does enough volume or revenue in the state to justify imposing tax. (See "nexus").
At least in the U.S., the real game is about how to apportion expenses to a state. Every state uses a different formula, and some, like CA, let taxpayers choose the formula most beneficial to them. (Note: apportionment is nothing like transfer pricing.)
Outside of the U.S.: If a business earns 20% of its revenue from directly Country A, then taxability is not a transfer pricing issue, it's a tax treaty issue. But you presumably mean the following: a big (foreign) business sets up a smaller business locally, and "leases" that IP to the local subsidiary, reducing the profits (and thus tax) the smaller company pays to the local tax authority. In that case, there isn't really anything the local country can do, because the situation is no different than the case of Unrelated Local Company A licensing an IP from Big Company in Other Country B. Many countries wouldn't allow that sort of tax discrimination based on company ownership, and in the countries where it would be allowed, foreign investment would drop precipitously because it would be riskier and less profitable to do business in that country.
The Delaware Court of Chancery is among the best in the world, if not the very best, and Delawareās corporation law is extremely well developed, far ahead of most other states.
When they teach corporation law in law school, they usually teach Delaware law. Itās the most advanced in the country.
Could you be a little more specific about what you mean by "best" and "most advanced"?
It's neither the best, nor the most advanced. It has two centuries of law pretty much focused on upholding management at the expense of all other parties' interests (including non-management shareholders).
Today, most new companies form as LLCs, which are regarded as the "most advanced" form of business entity for legal and tax purposes. In that regard, Wyoming is generally considered to have the "most advanced" law because many governing LLC concepts and regulations originate there first.
> Wyoming is generally considered to have the "most advanced" law
This is a novel opinion. In my experience, non-Wyoming residents self identify as being unable to afford Delawareās franchise tax. That, combined with its shallow bench, means one can blast an adversary out of the water by retaining the majority of Cheyenne, Casper and Laramieās legal talent before pressing your cost advantage.
> In Delaware, there are 2 huge registered agent firms:
> CT Corporation (1209 Orange Street) is home to 285k+ businesses, including Walmart, Apple, and Coca-Cola
Apple may be using that firm for something, but Apple is not incorporated in Delaware. Their state of incorporation is California according to their SEC filings, and has been since at least as far back as 1994.
Apple has state based branches registered in many states that it does business: https://opencorporates.com/companies/us_ca/C0806592/statemen...
These are so irrelevant to the California corporation that Apple has argued in court that thereās no corporate nexus in Delaware and so litigation there is not a valid venue: https://finance.yahoo.com/news/judge-single-apple-store-make...
It didnāt work, but the ruling was based more around the existence of a retail store there than anything else.
Yes, came here to post this. No evidence that Apple is incorporated in Delaware. How many other companies did they get wrong?
It seems the only mentions of Apple being incorporated in Delaware are from news articles and infopieces like TFA, no actual documents showing they are.
It doesn't seem to be the case. From their last 10-K: "The Company is a California corporation established in 1977."
I did YC startup school (twice, actually), and one of the first courses was about the legal aspects of setting up your company. The talk basically said "just register in Delaware", without explaining why.
For me as a European (and many other non-US founders in my SuS group) the course material was basically useless. But we did have a good discussion afterwards on loopholes, and why they exist in such way in the US.
As I understand it, Delaware is what Dublin is to Europe.
I'm not sure what country you're from, but do you feel that there are less tax loopholes there?
I'm from the Netherlands. I don't know much about tax loopholes though.
I do remember reading about some loophole possible through the Netherlands, called the 'Dutch Sandwhich' [0] hence why there are supposedly a lot of companies with just a postbox address in Amsterdam (we call these 'postvakbedrijven' in dutch). Not sure what the extend of this loophole is, or if it is still possible to exploit.
I wouldn't bet my company on it though, I prefer just to pay tax in my own country. I see it as my contribution to society.
It seems like there are many situations where a company is definitely following all laws and is extracting value or relative value by making certain decisions that have tax or other advantages.
It also seems like the general public directs outrage or anger at these companies in response to these decisions.
Why the anger at the companies and not the lawmakers who made the system in which the companies are legally operating?
Is it difficult to look up who moved the laws forward? Is it just because it's easier to point fingers at a company?
Here's how I think the average joe sees things. Most people here may not fall into this category, but certainly know people who do:
A) Politicians only listen to money; even ones that are on your side; laws therefore are skewed towards those who have money.
B) Companies donate large sums of money to politicians; therefore they listen to companies.
C) Very rich individuals also donate large sums of money, but the average joe can't figure those names out on their own and will rely on rumor mills from social media, and media propaganda from his/her political tribe.
So people will get mad at companies first because they are more visible and the fact that it's more possible for a non-rich person to get people to stop spending money at a corporation than making a lawmaker do what you want.
There are many levels to this but generally there is an idea that politics and especially laws like these are shaped by those who benefit from them the most - big businesses who can afford lobbying.
In terms of theory there is a Marxist notion of 'ruling class'. In regards to capitalism Marxists think that ruling class of capitalism is big business, not the State itself. Politicians are in a weaker position and just implement the will of the captains of the industry. That is rather extreme notion but still one can see traces of it in society.
And it generally goes both ways - companies have poor (but legal) working conditions and oppose any legislation or action that would change it by being anti-union, by funding thinktanks that do studies that prove raising minimal wage would lead to overall decrease of jobs etc.
What can you do about politicians?
They're all sell-outs. When election time comes you vote your side, hope the other side doesn't win and then spend the next for year ignoring what your guy is doing or criticising what the other side's guy is doing.
Sure, you could vote the libertarian party, good luck going higher than 3%. Even if they were successful, what are the chances they won't become as corrupted as other politicians once they have the power?
In the last 200 years the USA government just got bigger and inequity has just increased.
Forget about politics, accept the leeches as part of life, joke that "Two things are unavoidable: death and taxes".
You can at least boycott large companies and stop purchasing their goods.
I find efforts to skirt rules and regulations very fascinating.
This reminds me of a discussion awhile back. When interest rates threatened to go negative due to European markets circa 2014-2015, I remember discussing with fellow economists just how negative rates could go. Ultimately, at some negative rate, we figured wealthy individuals would remove their capital from the market and put it in warehouses with armed guards. The maintenance cost would eventually be lower in that approach than to leave in banks (charging higher fees as rates increased) or similar.
Ultimately it was speculative only, thankfully, since capital inflows from Europe to the US kept the rates higher than zero.
Fascinating stuff!
Incorporating in Delaware is the exact opposite of trying "to skirt rules and regulations". It is based on the desire for well defined, stable rules and relatively efficient enforcement.
As would the solution I mentioned regarding negative interest rates.
Both are evidence of competing regulatory systems, which is why I consider it fascinating.
> Ultimately it was speculative only
Not really. In e.g. the Netherlands you've to pay a 0.5% interest rate over the balance above ā¬100k, ā¬250k or ā¬500k at most banks.
Of course most people that hit the cap just spread out their money over multiple banks, use a savings deposit that still gives zero or positive interest, or invest it.
Not too different than the concept of precious metals depositories I guess. I don't know what the yearly tithe is in places like Singapore for this service, but one problem would be the physical size of the cash.
Maybe they should reissue the $100k federal reserve note for public consumption.
There's something that's been bothering me for a long time about interest rate policy.
In general, I have the impression that people take for granted that lower rates are "easier" even when they go negative.
However, it vaguely seemed to me that either side of zero should be considered "tightening". The sign determines which way money is going, but the absolute magnitude constitutes the friction.
So I've wondered if negative rate policy was counterproductive.
Does that make any sense at all?
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