Domestic Corporation: Everything You Need to Know
A domestic corporation is a business that operates within its home country. It may carry out activities in other regions of the country where it incorporates.6 min read
A domestic corporation is a business that operates within its home country. It may carry out activities in other states or regions of the country where it incorporates. This is in comparison to a foreign corporation, which operates in a country that it is not its homeland. The two types of entities are taxed differently. Domestic corporations may have to pay duties or fees on imported products. Like all corporations, domestic corporations must abide by domestic regulations and business practices. Many corporations operate in multiple countries and are domestic corporations only in the home country.
National or Federal Definition
For tax classification, the Internal Revenue Service (IRS) defines a corporation started in any state or a United States territory as a domestic corporation if they are subject to the laws of that governmental unit.
A business that is authorized by the Secretary of State in State X to operate in State Y is a foreign corporation in State Y.
State Definition Examples
Delaware is home to many businesses because it offers corporation-friendly laws and many forms of protection. Nevada is another example of a state that has created a business-friendly environment with privacy laws that keep shareholder names out of the public. It also has no state income tax.
If a business incorporates in Delaware, it can still carry out activities in any other state. In the past, there was some advantage to incorporating in Delaware, since the state had very liberal laws; however, in recent years, most states have relaxed their corporation laws, so today there are fewer advantages.
Still, Delaware attracts businesses through a number of other corporation-friendly entities.
- Delaware has more relaxed usury laws, which deal with the interest rates that banks and credit card companies can charge. Once incorporated in Delaware, financial institutions can apply those same rates nationwide.
- Delaware's Court of Chancery handles disputes between corporations in the state. It has an extensive library of precedents, statutes, and case studies from more than 200 years of operation. Delaware cases are often used as the benchmark for cases across the country. All of this makes the Court an excellent resource for companies.
- If a company incorporates in Delaware, they are subject to Delaware laws. However, if it incorporates in Delaware but doesn't do business there, then it is a foreign corporation.
Domesticating a Foreign Corporation
An existing corporation that wants to conduct business in a state other than where it formed must qualify as a foreign corporation in that state. The requirements for qualification are similar to forming the corporation. Paperwork must be filed with the proper state agency. The corporation may choose to domesticate elsewhere instead of operating as a foreign corporation. The requirements for domestication include filing the proper forms and dissolving or ceasing existence in the state where the corporation was originally formed.
Creation and Organization of Corporations
Incorporation is the legal process used to form a corporation. It happens when shareholders take the step to incorporate for some common goals. Those goals might be profit-related, and they usually are, but there are circumstances where they aren't. Charities, for example, often incorporate.
Around the world, corporations are the most widely used legal vehicle for operating a business, and almost every country has them. Often the terms "Inc." or "Limited" appear in the name so they are easy to recognize. In fact, most of the names people recognize immediately in the business world, like Google and Coca-Cola, are corporations. They may do business under other names, like Alphabet, Inc. for Google. In the United States, the most common form of corporation is a C Corporation.
While the legal details of a corporation's formation and organization differ from jurisdiction to jurisdiction, most have certain elements in common. Companies are owned by shareholders. Small companies may have just one, while a very large publicly traded one may have thousands. The shareholders elect the directors, usually annually, who decide the day-to-day activities of the company. Again, small companies may only have one director while larger ones have an entire board of 12 or more.
Advantages of Incorporation
Incorporation has a lot of positives for a business and the owners.
- The corporation has its own legal identity, along with most of the same rights and responsibilities of an individual. It can enter contracts, loan and borrow money, sue and be sued, hire employees, own property, and it must pay taxes.
- The personal assets of the owner are protected because the corporation has its own identity and stands good for its own debts. That's commonly called the corporate veil. It also protects the shareholders and directors so they're more willing to take risks to grow the company. While it may involve some risk to the original investment, their personal homes, money, and other resources are not on the line.
- If the company needs to change hands, that happens easier with a corporation through the sale of shares.
- Taxes for a corporation are lower than those applied to personal income.
- Financing for capital and other projects is easier through the sale of stock.
Articles of Incorporation
The documents filed with the government to incorporate are the corporate charter, articles of association, or certificate of incorporation. They must include relevant information about the business like name, address, agent, and type and amount of stock issued. The corporation's purpose must be included in the articles of incorporation in most states.
The purpose may be very broad to allow for the greatest flexibility in the day-to-day operations. The document may also include details on the role of the directors, stockholders, meetings, and more. Along with the articles, the bylaws of a corporation set forth how the company operates. These two documents are the framework of the corporation's structure.
In every state, new corporations must pay a state fee and possibly a franchise tax. Some states are very successful at attracting new corporations because of business-friendly tax structures and fewer regulations.
A new corporation is born with the corporate charter. This must be in place before any transactions can happen. As soon as it's filed and approved, the business can run legally. Doing business before the charter is complete puts the owners at risk personally because they are liable for damages, debts, and other consequences of doing business.
Day-to-Day Operations of a Corporation
Shareholders usually have one vote for every share of stock they own. They use those votes to elect the Board of Directors, and that Board oversees the day-to-day operation and carries out the business plan. Though they aren't personally liable for the debts of the business, they are duty-bound to take care of the business and can be personally liable if they don't. Some tax laws even address this.
Liquidation of a Corporation
Corporations have a life cycle, and there may come a point where the company has achieved its purpose. At that time, the company can be legally dissolved through liquidation or winding up. A professional liquidator is appointed, assets are sold, debts are paid, and anything leftover gets distributed to the shareholders. This process can be by choice or not. If it is involuntary, it is usually because of debts and may lead to bankruptcy.
If a corporation lapses due to not following the tax and reporting requirements, many states let a domestic corporation regain the corporate status within certain deadlines.
While domestic and foreign corporations both begin in the United States, an alien corporation is one formed outside the country. They may occasionally be called foreign corporations but that is technically incorrect.
Foreign Currency Effects
Foreign currency effects are gains or losses on foreign investments. They happen when the value of assets owned in a country outside the home country decreases due to changes in currency. As currency in the home country goes up, assets in another country bring lower returns when the company converts them back to the currency of the home country. The reverse is true for a falling home currency.
Breaking Down Foreign Currency Effects
Changes in the value of currency make foreign investments complicated. What is highly valued in one country may be worthless in another. It also makes borrowing money in a foreign currency more of a risk. Many corporations have found themselves bankrupt when domestic currency rose or fell sharply.
Foreign qualification is getting a legal permit to do business outside the home state of a corporation. Without this, the corporation may not be protected by the courts in the foreign state.
Breaking Down Foreign Qualification
Foreign qualification comes from the Secretary of State in the foreign state. Typically, the company files an application and pays the fee, usually a few hundred dollars. A business name (cannot already exist in the foreign state) and a local representative are named in the documents.
A business owner deciding where to domesticate his corporation generally considers the advantages the corporate laws of a given state may have for the corporation and its shareholders.
A business in a state with a high corporate tax rate would gain no benefit from incorporating in a state with little or no corporate tax if the company derived all its income within its home state.
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