Setting Up a US Subsidiary of a Foreign Company: Steps, Year One

How do you set up a US subsidiary of a foreign company?

A foreign parent forms the subsidiary under one state's corporate law, then gives it shares, a tax ID, a bank account and registrations in the states where it works. The order matters, because each step needs a document from the one before it.

1. Choose the state of incorporation, and list separately the states where staff, offices and customers will be.
2. Pick a name and a registered agent with a street address in that state. Delaware, for example, requires every entity to keep one.
3. File the certificate of incorporation. In Delaware it states, among other things, the name, registered agent, purpose, and the number of authorized shares with their par value (Delaware Code, title 8, section 102).
4. Organize the corporation. The incorporator or the initial directors adopt bylaws and elect directors, and the directors elect officers (section 108).
5. Approve the share issue to the parent by board resolution and subscription agreement; record the shares in the stock ledger once the parent pays into the subsidiary's own bank account (step 7).
6. Get the EIN on Form SS-4, naming as responsible party the individual who controls the subsidiary, never the parent.
7. Open the US bank account (see the bank section below).
8. Register to do business in each other state where the subsidiary operates. State law calls this qualifying as a "foreign corporation", meaning one formed in another US state.
9. Open payroll and sales tax accounts before the first paycheck or taxable sale, in each state where they apply (payroll setup).
10. File the BE-13 report with the Bureau of Economic Analysis within 45 calendar days of establishing the subsidiary.

What makes it not simple: the parent pays US bills from abroad and nobody records whether the subsidiary owes the money back; the parent charges fees, interest or royalties; the parent contributes equipment, inventory or intellectual property for shares; or staff work in several states. Most of these surface with the first intercompany invoice or the first Form 1120 and Form 5472. The parent's own country may also have rules for the new subsidiary; this page covers the US side.

Gather first: the parent's registration certificate and an ownership chart traced up to individuals; names, addresses and identification of the subsidiary's directors and officers, wherever they live; the funding plan (how much for shares, how much as a loan, and when); where staff, offices and customers will be; the parent's financial year-end; and the services, licence or supply arrangements planned with the parent.

Which state should a foreign parent incorporate in?

Any state can be the formation state, and the subsidiary must also register in each state where it actually does business. Forming in the state where it operates avoids a second state's annual report and tax; forming elsewhere adds them on top of the operating state's.

A Delaware corporation files an annual report and pays franchise tax by March 1 of the following year; the report fee alone is $50 (Delaware). The operating state taxes the subsidiary too: California, for one, requires Form 100 from any corporation registered with its Secretary of State or doing business there (California FTB). For the comparison, see which state to form in; for the second registration, see registering in another state.

How are shares issued to the parent, and what paperwork proves it?

The board issues the shares by resolution for the price it sets, the parent pays, and the corporation records the shares in its stock ledger. Under Delaware law the board may accept cash, tangible or intangible property, or another benefit to the corporation (section 152).

Keep one file with the certificate of incorporation, the bylaws, the organizing consent, the board resolution issuing the shares, the parent's subscription document, the wire confirmation and the stock ledger entry. These records show the money was paid for shares, not lent or earned.

Property for shares. If the parent transfers equipment, inventory or intellectual property solely for shares and controls the subsidiary right after, section 351 generally means no gain or loss is recognized on the exchange. The subsidiary then attaches a statement to its return for that year giving the property's fair market value and tax basis (26 CFR 1.351-3(b)), so keep the valuation behind it. If the property is worth less than its basis, the subsidiary's basis can drop to fair market value (section 362(e); see foreign company entering the US). The transfer may also need a description in Form 5472 Part VI.

Why authorized shares and par value matter in Delaware. Delaware franchise tax can be figured two ways, and Delaware says to use the method with the lesser tax (Delaware):

Many authorized shares can mean a large bill under the first method, so settle the share count and par value before filing. The first year's tax is prorated for the part of the year the corporation existed (section 503(d)). See Delaware franchise tax.

Who is the responsible party on the EIN application when the parent is a company?

An individual, never the parent company. The Form SS-4 instructions define the responsible party as the natural person who ultimately owns or controls the entity or exercises ultimate effective control over it and its funds; they name the principal officer outright only for publicly traded or SEC-registered entities (Form SS-4 instructions). The IRS's summary page says a corporation's is usually the principal officer (IRS). For a subsidiary, name the individual who actually directs it, such as its president or the parent's managing director. A formation agent or other nominee cannot be listed.

Enter that person's SSN or ITIN on line 7b, or "foreign" or N/A if they do not have one and are not eligible for one (Form SS-4 instructions). Apply after the state accepts the certificate, using the exact legal name it shows.

If the responsible party has no SSN or ITIN, online is closed: a subsidiary with a US office faxes or mails to the domestic number and address, and the phone line is not open to it. When a signature is required, the president, a vice president or another principal officer signs Form SS-4 (IRS). If the named officer leaves, report the new responsible party on Form 8822-B within 60 days. For detail, see EIN without an SSN.

Who signs, and what does a US bank need from a foreign parent?

The subsidiary's officers sign for it; the parent acts only as shareholder. Delaware requires each director to be an individual, not the parent company, but sets no residency rule and does not require directors to own shares (section 141(b)). The board elects the officers, an authorized officer such as the president or treasurer signs Form 1120 (IRS), and a board resolution should name who may sign on the bank account. Anyone who controls the subsidiary's funds and willfully lets withheld payroll tax go unpaid can be personally liable for that amount (26 U.S.C. 6672; see trust fund recovery penalty).

A US bank must identify each individual who directly or indirectly owns 25% or more of a business customer, looking through the parent, plus one individual who controls it, such as the chief executive (FinCEN). If no one reaches that share, as with a widely held parent, the bank still identifies the control person. Bring the ownership chart down to those people, their identification, the parent's registration documents, the certificate of incorporation, the EIN notice and the board resolution. Address and agent choices are in US business addresses and bank accounts.

Does the subsidiary file a BOI report?

No. FinCEN's final rule exempts every company created in the United States from beneficial ownership information reporting; the duty now falls only on entities formed abroad that register to do business in a state and have no exemption (FinCEN). If the parent itself registers in a state, see who still files a BOI report.

Is there a federal survey for a new foreign-owned US business?

Yes. A new US business in which a foreign entity owns 10% or more of the voting interest must file a BE-13 report with the Bureau of Economic Analysis, whether or not the bureau contacts it (15 CFR 801.7). It is due within 45 calendar days of establishing the subsidiary and is separate from the tax returns below.

What does the subsidiary file in year one?

Form 1120 for its first tax year, with one Form 5472 for each foreign related party it had a reportable transaction with, plus state, payroll and withholding filings as they apply. Every domestic corporation files Form 1120 whether or not it has income, and checks "Initial return" on the first one (IRS).

Form 1120, Schedule K, question 7 asks whether one foreign person owns 25% or more (IRS). A missing or substantially incomplete Form 5472, or failing to keep the required records, carries a $25,000 penalty (IRS).

Charges from the parent can need US withholding: interest, and royalties for rights used in the US, generally do, at 30% unless a treaty lowers it; a service fee depends on where the work is done, and goes on Form 5472 either way (Publication 515). The treaty rate applies only if the parent's Form W-8BEN-E is in the subsidiary's hands before the payment, and the subsidiary itself owes any tax it fails to withhold, with interest and penalties (Publication 515; 26 U.S.C. 1461). Pricing and withholding are covered in US subsidiary of a foreign company; first-year installments in first-year estimated tax.

When does the first tax year start and end, and must it match the parent's year-end?

The first tax year starts on the date of incorporation and ends on the year-end the subsidiary chooses, so the first return usually covers a short period (Publication 538). A new C corporation adopts its tax year by filing its first return on that basis; the closing month entered on Form SS-4 does not adopt it.

The federal rules for a new C corporation do not tie its year-end to the parent's, so matching is a choice, unless the subsidiary is a personal service corporation (consulting, engineering and similar services performed by employee-owners), which generally must use the calendar year (Form 1120 instructions). Changing the year later generally needs IRS approval on Form 1128 (Form 1120 instructions). A short first-year return is due on the 15th day of the fourth month after year-end, whatever month the year ends in, including June (26 U.S.C. 6072 and notes). For the accounting year, standard and currency of the books, see books for a US subsidiary of a foreign parent.

Is the parent's first funding a reportable transaction?

A loan from the parent is reportable; a cash purchase of new shares, by itself, is not on a C corporation's Form 5472 list. Part IV reports amounts borrowed on line 17, as beginning and ending balances or a monthly average, and interest paid on line 32. Its catch-all line for other amounts received counts only amounts that enter the subsidiary's taxable income, which payment for its own new shares does not (Form 5472 instructions). The regulation's item for formation payments and contributions applies only to foreign-owned disregarded entities (26 CFR 1.6038A-2(b)(3)).

The trap: the parent pays US rent, salaries or suppliers directly from abroad, and nobody records whether each payment is a loan or capital until the first return is due. Decide and document it when the money moves. For shares versus a loan, see foreign company entering the US; for the records, see putting money into a US corporation from abroad.

Example

Illustrative amounts in US dollars.

A Japanese parent with a California office

A Japanese company incorporates a Delaware subsidiary with 1,000,000 authorized shares and issues all of them to itself for US$500,000 cash. Its chief executive, who is also the subsidiary's president, is the responsible party; with no SSN or ITIN and no eligibility for one, line 7b says "foreign". Because the office is in California, the subsidiary is not an international applicant and faxes Form SS-4 to the IRS's domestic fax number. It registers in California and, with setup costs far below US$40 million, files a BE-13 Claim for Exemption within 45 days.

Year one: Form 1120, answering yes to question 7; the US$500,000 share purchase alone needs no Form 5472. For a full year, Delaware's authorized shares method would give US$8,665. The assumed par value capital method gives the US$400 minimum: US$500,000 of assets over 1,000,000 issued shares is US$0.50 a share, times 1,000,000 authorized shares (stated par being lower) is US$500,000. It owes the lesser tax, US$400 prorated for the part of the first year it existed, plus the US$50 report fee; see Delaware franchise tax. California: Form 100; a newly qualified corporation does not pay the US$800 minimum tax in its first year, but any income is taxed at 8.84%.

The parent bills for support services

The same subsidiary pays the parent US$200,000 for support services its staff perform in Japan. Form 5472 is now required: one form for the parent, with the fee on Part IV line 29. A fee for services performed wholly outside the US is generally foreign-source, so no US withholding applies, but the price must still be arm's length.

A UK parent forms the subsidiary in November

A UK parent with a March 31 year-end incorporates its subsidiary on November 10. With a calendar year-end, the first Form 1120 covers November 10 to December 31 and is due April 15. With a March 31 year-end to match the parent, it covers November 10 to March 31 and is due July 15. Either way, Delaware's first annual report is due March 1, with franchise tax prorated for November 10 to December 31. If the parent lends US$100,000 on December 1, line 17 shows US$0 at the start and US$100,000 at the end of the first tax year.

Different for you?

• Your parent is Canadian: use setting up a US subsidiary from Canada, which adds the Canadian parent's filings.
• You have not chosen between a branch, a subsidiary or an LLC, or between shares and a loan: see foreign company entering the US.
• The parent wants to own a US LLC instead: see an LLC owned by a corporation.
• The parent will charge fees, interest or royalties: pricing and withholding are in US subsidiary of a foreign company; if payments already went out without withholding, see missed withholding on payments abroad.
• The first Form 1120 and Form 5472, or the first intercompany invoice, is coming up: bring the share records, loan papers and parent invoices to corporate tax help.
• The parent has been paying US rent, salaries or suppliers directly: each payment needs to be sorted into loan or capital before the first return; see putting money into a US corporation from abroad and get corporate tax help.
• A Form 5472 was missed or a penalty notice arrived: see missed foreign-owner filings and penalties and get corporate tax help.
• You need the books, currency and payroll set up: see books for a US subsidiary of a foreign parent or get bookkeeping help.
• The subsidiary was formed late in the year and little happened: see filing for the year you formed.