Setting Up the Business

Ownership Structure
Forms of business organizations are:
 Sole proprietorship:

Advantages: Easy to organize and simple to control;

flexible to manage; subject to minimal government
control; owner taxed as an individual at a lower rate
than corporate income tax.
Disadvantages: risk of unlimited liability; limited
access to capital and terminates upon death or
disability of the owner.
 Partnership: Advantages: Share of business
costs and management; no tax liability ie.,
profits/losses included in partner’s income tax
return. Disadvantages: Personal liability and
partner’s action can bind the partnership.
 Corporation: Advantages: limited liability;

free transferability of shares, perpetual

existence; ability to raise funds.
Disadvantages: double taxation.
 A limited partnership is a special form of partnership
which consists of at least one general (investor and
manager) partner and one or more limited (investor)
partners. The general partner is given the right to
manage the partnership and personally liable for the
debts and obligations of the limited partnership.

 S Corporations offer the benefits of limited liability,

but still permits the owner to pay taxes as an
individual, thereby, avoiding double taxation.
1. Domestic entity: The Corporation must be a domestic entity, that is, it must be incorporated
in the United States.
2. No membership in an affiliated group: The Corporation cannot be a member of an affiliated
group (not part of another organization).
3. Number of shareholders: The Corporation can have no more than seventy-five shareholders.
4. Shareholders: Shareholders must be individuals or estates. Corporations and partnerships
cannot be shareholders. Shareholders must also be citizens or residents of the United States.
5. Classes of stock: The Corporation cannot have more than one class of stock.
6. Corporate income: No more than 20 percent of the corporation’s income can be from
passive investment income (dividends, interest, royalties, rents, annuities, etc.).
 Formation Duration Management Owner Liability Transferability of Owners’ Federal Income Taxation
Interest

Sole Proprietorship One person owns business. No Corporation or Terminates on death or By sole proprietor Unlimited None Only sole proprietor taxed
LLC formed. withdrawal of owner

Partnership By agreement of owners or by default when two Usually unaffected by By partners Unlimited Limited Only partners taxed
or more owners conduct business together death or withdrawal of
without creating another business form partner

Limited Liability By agreement of owners; must comply with Usually unaffected by By partners Limited to capital contribution, except Limited Usually only partners taxed; may elect to
Partnership limited liability partnership statute death or withdrawal of for owner’s individual torts be taxed like a corporation
partner

Limited Partnership By agreement of owners; must comply with Unaffected by death or By general partners Unlimited for general partners; limited Limited, unless agreed Usually only partners taxed; may elect to
limited partnership statute withdrawal of partner to capital contribution for limited otherwise be taxed like a corporation
partners

Limited Liability Limited By agreement of owners; must comply with Unaffected by death or By general partners Limited to capital contribution, except Limited, unless agreed Usually only partners taxed; may elect to
Partnership limited liability limited partnership statute withdrawal of partner for owner’s individual torts otherwise be taxed like a corporation

Corporation By agreement of owners; must comply with Unaffected by death or By board of directors Limited to capital contribution, except Freely transferable, although Corporation taxed; shareholders taxed on
corporation statute withdrawal of shareholder for owner’s individual torts shareholders may agree dividends (double tax)
otherwise

S Corporation By agreement of owners; must comply with Unaffected by death or By board of directors Limited to capital contribution, except Freely transferable, although Only shareholders taxed
corporation statute; must elect S Corporation withdrawal of shareholder for owner’s individual torts shareholders usually agree
status under Internal Revenue Code otherwise

Limited Liability Company By agreement of owners; must comply with Usually unaffected by By members, unless choose Limited to capital contribution, except Limited, unless agreed Usually only members taxed; may elect
limited liability company statute death or withdrawal of to be manager-managed for owner’s individual torts otherwise to be taxed like a corporation
member
 Business or Trade Name
Corporations are required to register their
trade name with the state
 Sole proprietorships and partnerships are

required to register with appropriate

government agency if they operate under
a fictitious name
Bank Accounts, Permits, and Licenses
An import/export business person can:
 Open an account with an international bank
 Operate from a home during the early phase of the

business; all direct expenses related to the business

are tax deductible
 Use of professional services: source of guidance on

liability, taxes, expansion, and related matters

 Check with the city or county to determine if permits

or business licenses are required

 Organizational Issues
 Level at which export decisions should be made
 Need for a separate export department
 Coordination and control of various activities
 Organizational structure of the export-import

department
 Organization of an export department of a

global company: Functional, product, market

and geographical basis.
 Organizing for Export:
Industry Approach
Organizational issues involve three related
areas:
 Subdivision of line operations based on

certain fundamental competencies

 Centralization or decentralization of

export tasks and functions

 Coordination and control
 Taxation of Export-Import
Transactions
General principles:
 Worldwide income of citizens, residents,

or business entities

 Definition of residency (183 days out of

a 3-year period or election)
 For U.S. tax purposes, an individual is
considered a U.S. resident if the person
a) has been issued a resident alien card (green
card),
b) has been physically present in the United
States for 183 days or more in the calendar
year or
c) meets the cumulative presence test
Example of cumulative presence test: If Jim (a UK citizen) was in California for sixty-six days in

2010, thirty-three days in 2011 and 162 days in 2012, he would be considered a U.S. resident for

2012 (162 + 33/3 + 66/6 = 184 days). Jim may, however, rebut this presumption by showing that he

has a closer connection to the UK than the U.S, or that his regular place of business is in the UK.

A company incorporated in the United States is subject to tax on its worldwide

income, as in the case of U.S. citizens and residents. A partnership is not treated as a
separate legal entity, and, hence, it does not pay taxes. Such income is taxed in the hands
of the individual partners, whether natural or legal entities.
 Foreign persons’ export profits are exempt from U.S.
tax unless such profits are attributable to a permanent
establishment maintained in the U.S. Similarly, U.S
exports will not be subject to tax in the importing
country unless the firm has a fixed place of trade or
business in the importing country or its agents in the
latter country have authority to conclude contracts on
behalf of the U.S. exporter.
 Deductions and allowances: organizational costs,
general and administrative expenses, personal and
business expenses, entertainment, travel, and other
related business expenses.
 Transfer pricing is intended to ensure that taxpayers
report and pay tax on their actual share of income
arising from controlled transactions. There are
several methods used to estimate an arm’s length
charge for transfers of tangible property: the
comparable uncontrolled price method, the resale
price method, the cost plus method, the comparable
profits method and the profit split method.
 U.S. Parent Co. (Steel Co.) U.S. Subsidiary
in Detroit, Michigan in Madrid, Spain

Option A Production Cost = 1000 Cost of sales = 1000

Selling expense = 200

Sale to subsidiary = 1000 Sales revenue = 2200

Net Profit = $0 Net Profit = $1000

Option B Production cost = 1000 Cost of sales = 2000

Selling expense = 200

Sales to subsidiary = 2000 Sales revenue = 2200

Net Profit = $1000 Net Profit = $0

Transfer Pricing Methods
A number of factors are considered in the
determination of comparable prices btw
parties: contractual terms, such as provisions
pertaining to volume of sales, warranty,
duration or extension of credit, functions
performed, risks assumed (currency
fluctuation, credit collection, product liability).
Other factors include economic market
conditions, nature of property or services
transformed.
 In the case of sale of tangible goods btw related
parties, the arm’s length charge is determined by
using the following methods:
- Comparable uncontrolled price method: uses prices
on the sale of similar goods to unrelated parties
- Resale price method: uses resale price to unrelated
parties using gross profit margin
- Cost-plus method: used in situations in which
products are manufactured and sold to related
parties
- Comparable-profits method: uses profit-level
indicators such as rate of return on operating
assets of uncontrolled parties to adjust profit levels
of each group
- Profit split method: allocates profit btw related
parties on the basis of the relative value of the
contribution to the profit of each party