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Structuring the international joint venture, partnerships or corporation


The most basic – and most important decision that a U.S. partner in an International Joint Venture (IJV) will need to make is whether the foreign business entity is a partnership or corporation. As difficult as this decision often is, with respect to domestic businesses, it is infinitely more difficult with respect to foreign entities.

For starters, the foreign jurisdiction will likely not even have “corporations” or “partnerships” at all, but a potpourri of strange-sounding entities that may or may not correspond to what we understand in the U.S. to be corporations or partnerships. For example, if the IJV will be located in Germany, will it be an “Aktiengesellschaft” or a “Gesellschaft mit beschränkter Haftung” (“GmbH”), or something else? Needless to say, it is foolhardy to attempt to traverse this minefield without the assistance of knowledgeable local counsel. And let’s not forget that the decision whether or not the foreign entity will be a corporation or a partnership should be made from a U.S. not foreign point of view.

A. Partnerships or Corporation- General Tax Principles

An IJV that elects to be taxed as a partnership for U.S. tax purposes will be taxed in much the

same fashion as a domestic partnership, i.e., the partnership will be a “pass-through” entity, with the partnership itself not subject to tax and the partners subject to tax on their allocable shares of partnership income and loss. If, as is often the case, the venture expects to incur losses in the first year of years of operation, operating in partnership form will result in the U.S. being able to use the IJV’s losses against its U.S. or other foreign income. If the IJV is taxed as a corporation, the losses cannot be allocated to the U.S. parent.

Conversely, if the IJV is taxed as a partnership and not it generates profits, the U.S. partner will be subject to immediate taxation on its share of profits, whether those profits are distributed or not, with no ability to defer the incidence of tax.

If however, the U.S. partner has unused foreign tax credits, it could use those credits to directly offset the profits allocated to it by the IJV. It would be able to use the foreign tax credits if the IJV were taxed as a corporation, and would be limited to the “deemed” foreign tax credit. Finally, if in the rare case the U.S. partner is an individual not a corporation, partnership taxation might be preferable (at least from a tax standpoint), because an individual or a S corporation does not qualify for the “deemed” foreign tax credit.

This discussion should make it clear that with respect to the most basic decision regarding how the IJV should be taxed, one size definitely does not fit all.

B. Limited and Unlimited Liability

No one wants to be sued. But if you are going to become a defendant in a lawsuit, you would much prefer to be sued in Tarzana, California than in Tanzania. Moreover, if your assets are to be placed at risk as a result of your foreign operations, you would prefer that you be held liable only for your own wrongdoing, which you have the ability to control, and not the wrongdoing of a business partner which has less ability to control.

Just as in the U.S. some forms of foreign business ownership provide more limitation from liability than others. If limited liability is a goal – and it should be – one of the first goals is to choose the form of foreign ownership that provides the most insulation from creditor claims.

For every U.S. state permits the formation within that state of a limited liability company (LLC), which provides not only for the limited liability of the owners (the “members”) being a tax partnership and therefore a “pass-through” entity for tax purposes. As such, the LLC is not considered a taxpayer at all. Instead, the owners are taxed on their proportionate share of the LLC’s profits, and are allocated their share of the LLC’s losses, if any. In that respect, an LLC is the most closely analogous to a U.S. corporation that elects to be treated as an “S” corporation. If a domestic corporation elects “S” status, the corporation itself is not a taxpayer; the shareholders pay their proportionate shares of the taxes of the corporation’s earnings.

Nevertheless, the shareholders have the same limited liability as the shareholders of a “regular”or “C” corporation. Not all countries provide for entities that are analogous to U.S. LLCs. Surprisingly, neither the Canadian federal government, which permits incorporation of federal entities, nor any of the Canadian provinces provide for the formation of an LLC or anything like it, i.e., an entity that is a “pass-through” for tax purposes but that provides for limited liability for all its owners. The closest thing that Canada has to our LLC is a limited partnership, which provides for limited liability for the limited partners, but which renders the general partner liable for all of the entities debts and liabilities.

Can an SCorporation Ever be a Partner in an International Joint Venture?

It doesn’t happen often, but there are occasions when a U.S. “S” corporation desires to engage in an IJC. An “S” corporation may be a partner in an IJV. Here’s how:

An “S” corporation may not have a corporate shareholder. With some unimportant exceptions, all of the “S” corporation’s shareholders must be U.S. individuals. The presence of a single foreign shareholder or one corporate shareholder will disqualify the entity as an “S” corporation for all its shareholders. Moreover, an “S” corporation may not be part of an “affiliated group” of corporations, i.e. it cannot own a corporate subsidiary.

There is, however, one important exception to this rule: An “S” corporation may own a “Qualified S Corporation Subsidiary,” universally known as a “QSub.” To qualify, the “S” corporation must own all of the stock of the QSub, which must be a domestic corporation. If these requirements are not met, the QSub is treated as an invisible entity for U.S. tax purposes.

The QSub may be an invisible entity for U.S. income tax purposes, but it is very real for all other purposes. For liability purposes, the QSub interposes a level of insulation between the local operating entity and the U.S. “S” corporation owner. If and to the extent local law of taxing authorities require disclosure of the parent of the local partner of the IJV, that parent is the QSub, not the “S” corporation. The diagram below is a visual representation of how a U.S. “S” corporation should engage in an International Joint Venture.

U.S. “S” Corporation

The diagram below is a visual representation of how a U.S. “S” corporation should engage in an International Joint Venture.


Jacob Stein
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91436 Los Angeles, CA
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