Entering the U.S. Market: Branches and Subsidiaries for Korean Companies

May 24, 2019

As more Korean companies enter the U.S. market, more are establishing U.S. branches or subsidiaries. Preparing for U.S. expansion involves more than forming a company: businesses should also consider the form of their presence, how transactions between Korean headquarters and the U.S. company will be handled, and preparations for expatriate assignments. Because U.S. branches and subsidiaries differ substantially in legal and tax treatment, it is important to choose a structure that fits the business plan from the outset.

1. Forms of U.S. Market Entry

The forms a Korean company generally considers when entering the United States are a representative office, a branch, and a subsidiary.

① Representative Office

A representative office is intended to perform limited activities such as U.S. market research, communication with headquarters, and publicity.

An office that conducts only basic market research or liaison activities may operate without forming a separate U.S. entity. However, care is needed because actual business activities in the United States, such as entering into contracts, selling products, or providing services, may be regarded as conducting a U.S. business. For tax purposes, the activities actually conducted in the United States matter more than the label ‘representative office.’

② U.S. Branch

A U.S. branch does not involve forming a separate U.S. corporation. Instead, the Korean corporation itself registers as a foreign corporation in the relevant U.S. state and conducts business directly. Because it is not a separate U.S. subsidiary, legal liabilities arising from U.S. operations can extend directly to Korean headquarters. A Korean corporation conducting business in the United States generally must also file a U.S. income tax return for a foreign corporation, Form 1120-F, and consider whether it has a permanent establishment under the U.S.–Korea tax treaty and whether Branch Profits Tax applies.

Although the formation structure may be relatively simple, tax consequences and legal liability should be carefully considered when long-term expansion of U.S. operations is planned.

③ U.S. Subsidiary

Under this approach, a Korean company forms a separate U.S. corporation under U.S. law. It is one of the most common structures for Korean businesses entering the U.S. market. For example, Korean headquarters may own 100% of the U.S. corporation’s shares, while the U.S. corporation handles local operations such as hiring employees, contracting with customers, generating revenue, and paying expenses.

A C Corporation is generally a commonly used form for a subsidiary of a Korean company.

A U.S. subsidiary must maintain accounting records separate from Korean headquarters and file U.S. corporate income tax returns. U.S. transfer pricing rules should also be considered if the Korean headquarters and U.S. entity engage in transactions involving product sales, management support fees, service fees, royalties, or loans. A U.S. corporation that is at least 25% directly or indirectly owned by a foreign shareholder and has transactions with overseas related parties, such as headquarters, may be subject to Form 5472 reporting. Planning U.S. expansion therefore requires designing the intercompany transaction structure and accounting treatment from the beginning, rather than simply forming a company.

2. Steps to Establish a U.S. Subsidiary

Specific procedures vary by the state of formation, but the process generally involves the following steps.

① Choose the State and Entity Type

First, decide in which state to form the company. A C Corporation is commonly used for a U.S. subsidiary of a Korean company, but the appropriate form should reflect business objectives, investment plans, and plans to attract outside investment. For example, a corporation formed in Delaware may also need to register as a foreign corporation in California if its actual business is conducted there. Accordingly, consider the state where the business premises and employees will be located, rather than choosing a state solely for ease of incorporation.

② File the Incorporation Documents

Submit Articles of Incorporation or a Certificate of Incorporation to the state government where the company will be formed. Basic company details, including its name, number of authorized shares, and registered agent, are determined at this stage.

③ Prepare Bylaws and Board Documents

After incorporation, prepare the company’s bylaws and initial board resolutions or organizational meeting minutes. These establish basic operating matters such as appointing officers, issuing shares, opening bank accounts, and selecting the fiscal year. If Korean headquarters provides 100% of the investment, shares in the U.S. corporation are issued to Korean headquarters as the shareholder.

④ Apply for an Employer Identification Number (EIN)

Apply to the Internal Revenue Service (IRS) for an Employer Identification Number (EIN). The EIN is the U.S. corporation’s tax identification number and is needed for most business activities, including corporate income tax returns, payroll filings, and opening bank accounts. A separate procedure is available to apply for an EIN even when the responsible party is a foreign individual who has neither a U.S. Social Security number nor an Individual Taxpayer Identification Number.

⑤ Open a Bank Account and Transfer Capital

After incorporating and obtaining an EIN, open a bank account in the U.S. corporation’s name and transfer the investment funds from Korean headquarters.

Banks have different identification and account-opening procedures for foreign-owned companies, so it is advisable to confirm required documents and whether an officer must appear in person. When transferring capital from Korea to the United States, also check Korean foreign exchange procedures, including overseas direct investment reporting.

⑥ Complete State and Local Registrations

Depending on the business location and type, state tax registration, payroll tax registration, a seller’s permit, business registration, and other operating licenses may be required. Businesses hiring employees should also prepare for payroll tax filings, workers’ compensation insurance, and other employment matters.

3. Intercompany Transactions Matter After Formation

After a Korean company establishes a U.S. subsidiary, transactions between Korean headquarters and the U.S. subsidiary require particular tax attention. Sales of products by headquarters to the U.S. entity, management support or service fees paid by the U.S. entity to headquarters, and operating loans from headquarters are all related-party transactions. U.S. tax law applies the Arm’s-Length Principle, requiring prices for such transactions to be comparable to those that independent parties would agree upon. A U.S. corporation that is at least 25% foreign-owned may also have Form 5472 reporting obligations for certain transactions with foreign related parties. Because omitting Form 5472 can result in substantial penalties, related-party transactions should be tracked separately from the outset. During formation, it is therefore advisable to consider the division of responsibilities between headquarters and the U.S. entity, product transfer prices and an appropriate U.S. profit margin, methods for calculating management support and service fees, intercompany loans and interest rates, trademark or technology royalties, relevant agreements, and transfer pricing documentation.

4. Assigning Korean Employees to the United States

After forming the U.S. company, an appropriate employment or intracompany transferee visa is required to assign officers or employees from Korean headquarters to the United States. L-1 and E-2 are among the visa categories commonly considered by Korean companies entering the U.S. market.

① L-1 Intracompany Transferee Visa

An L-1 application may be made when the Korean headquarters and U.S. company have a qualifying relationship, such as parent and subsidiary, affiliates, or a branch, and the employee meets the eligibility requirements. L-1A is primarily for managers and executives, while L-1B is for employees with specialized knowledge needed for the company’s operations. Generally, the applicant must have worked continuously for Korean headquarters or a foreign related company for at least one year within the three years before the U.S. assignment. A newly established U.S. company may also apply for a New Office L-1.

It is therefore not always necessary to accumulate three or six months of operating results after forming a U.S. company before applying for an L-1. A new company should, however, demonstrate U.S. business premises, the investment amount and financial capacity, a business plan, projected revenue, hiring plans, and organizational structure, showing that the transferee will perform a genuine managerial or executive role as U.S. operations grow. Initial L-1 approval for a new office is generally limited to one year, after which an extension is requested based on actual operating results and organizational structure.

② E-2 Investor and Employee Visas

Because Korea has the relevant treaty with the United States, Korean investors or employees meeting certain requirements may use the E-2 visa. The key is not simply investing more than a fixed amount: a substantial investment relative to the size of the business must actually have been made, and the enterprise must genuinely operate in the United States. It must also be more than a business that merely supports the investor and the investor’s family. Accordingly, there is no uniform rule specifying a minimum investment or a minimum number of U.S. employees for an E-2. The nature and scale of the business, the amount actually invested and how it is spent, the business plan, and future hiring plans are considered together. If a Korean company owns at least 50% of the U.S. entity, it may also consider assigning eligible Korean officers or employees on E-2 employee visas. Because E-2 is a nonimmigrant visa, it differs from L-1A in long-term residence and permanent residency planning. The appropriate visa should therefore reflect both the company’s U.S. business plan and the expatriate’s long-term plans.

5. Planning the Structure Matters More Than Formation Alone

Forming a U.S. company itself is relatively straightforward. In practice, however, the accounting and tax issues after formation are much more significant. Korean companies entering the United States should consider together: ① choosing a branch or subsidiary, ② investment and financing structure, ③ transfer pricing between headquarters and the U.S. entity, ④ international tax reporting such as Form 5472, ⑤ expatriate visas, and ⑥ consolidated accounting and K-IFRS reporting for Korean headquarters.

For example, a U.S. company may begin with a simple capital transfer from headquarters, but expansion can produce a wide range of related-party transactions: product sales, allocations of personnel and administrative expenses, loans and interest, and trademark and technology royalties. Trying to organize these transactions after operations are well underway can complicate accounting and tax treatment and create unexpected taxes or reporting obligations. Korean companies preparing for U.S. expansion should therefore determine their entry structure by considering future business scale and staffing, intercompany transactions, and plans for raising and recovering investment funds, rather than simply forming a U.S. company first.

Peter M. Sohn, CPA

Dow & Sohn CPAs