It may come as a surprise to hear that Delaware, the second smallest U.S. state, is one of the most desirable locations for both foreign and domestic businesses to incorporate. More than half of all publicly traded U.S. companies are incorporated in Delaware.
Delaware’s popularity isn’t accidental. State authorities have spent decades developing the legal framework necessary to attract and retain corporations of all kinds. Delaware has flexible business laws, a highly specialized judicial system and a corporate-friendly tax code.
This post addresses some of the history of Delaware’s rise to prominence as an incorporation destination, provides some details about the state’s advantages, and explains why your business needs to consider incorporating in Delaware without assuming it’s the best option.
Delaware General Corporation Law
The Delaware General Corporation Law (DGCL) was formed in large part to attract businesses to Delaware. It’s among the most advanced and flexible business-formation statutes in the nation, and relative to similar legislation in other U.S. states provides a quick and cheap path to entity establishment. In many cases, a business can incorporate in Delaware in 24 hours for about 89 U.S. dollars.
The DGCL also gives businesses the freedom to create their own corporate governance structures. For example, one person can simultaneously hold the position of shareholder, director and officer in Delaware, whereas many other states require three separate people to fill these positions. In addition, Delaware-incorporated shareholders and directors enjoy relatively high levels of privacy and anonymity. They’re not required to be Delaware state residents, nor are they required to disclose their names or any other personal information on formation documents.
Delaware’s Division of Corporations has shown a commitment to efficiency and to minimizing red tape. The majority of its filing services are offered online, so businesses can easily file annual tax reports and other documents.
In addition to providing prompt and reliable service, Delaware recognizes the importance of staying up-to-date with corporate trends. Each year, the state legislature meets with corporate lawyers to review the DGCL and recommend any amendments deemed necessary to keep the law current and business-friendly. Once an amendment is suggested, it must win a super-majority vote by legislature to be passed into law. According to Delaware.gov, this system protects the DGCL from “one-time amendments proposed by special-interest groups or influential corporations,” and keeps the law stable and predictable so business leaders can accurately plan their long-term strategies.
Delaware’s judicial system
Delaware’s judicial system is widely recognized as the nation’s leading forum for adjudicating corporate disputes. The state’s Court of Chancery provides hundreds of years of legal precedent to draw from, resulting in relatively quick, predictable outcomes. In addition, most U.S. corporate lawyers are familiar with Delaware law, providing a large pool of experts for corporations in need of counsel.
Perhaps most significantly, judges — not juries — provide rulings in Delaware cases. This eliminates the need to educate juries on the intricacies of corporate law and generally saves companies time and money when in litigation. Delaware judges are moreover highly specialised, so litigators can typically trust that a business-related ruling will be fair and unaffected by public opinion or other extraneous factors. As a result, corporations can confidently assess the probable outcomes of a legal dispute.
Delaware also attracts corporations due to its relatively favourable state tax regime, which gives businesses several ways to legally minimize their tax bills. The New York Times explains that Delaware laws allow companies “to lower their taxes in another state by shifting royalties and similar revenues to holding companies in Delaware, where they are not taxed.”
Delaware does in fact have a corporate income tax, but intangible assets such as loans, patents, trademarks and leases are exempt under Delaware tax law. In order to reduce their tax bills, many companies establish subsidiaries in Delaware to hold tax-exempt intangible assets while at the same time doing business in another state. When the parent company pays royalties to the Delaware subsidiary, it generates deductions in the state where it’s doing business. This arrangement has been coined the “Delaware loophole” and is the subject of controversy among lawmakers in other states, such as Pennsylvania, who believe their states are being robbed of tax dollars.
Finally, Delaware doesn’t charge corporate income tax to companies that are formed in Delaware but don’t conduct business there. These companies are, however, subject to an annual franchise tax based on the total value of their shares.
The benefits of incorporating in Delaware are clear, but there are other U.S. states such as Nevada and Wyoming that offer similar benefits. As a result, non-U.S. companies considering expanding into the U.S. must not assume Delaware is the best choice of states in which to incorporate. They must consider the nature of their activities, short- and long-term goals, their tax structures, where they will be opening their office or offices, where their customers are located, and individual state tax regulations, among other factors.
Virtually any company in this situation will want to consult with a third-party expert familiar with U.S. state business legislation to review options and determine the optimal solution based on circumstances.
Deeksha Chopra, US Tax Associate, contributed to this article.
The contents of this article are intended for informational purposes only. The article should not be relied on as legal or other professional advice. Neither Vistra Group Holding S.A. nor any of its group companies, subsidiaries or affiliates accept responsibility for any loss occasioned by actions taken or refrained from as a result of reading or otherwise consuming this article. For details, read our Legal and Regulatory notice at: http://www.vistra.com/notices . Copyright © 2022 by Vistra Group Holdings SA. All Rights Reserved.
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