The national press has reported a growing resentment among states toward companies with Delaware Holding Companies (DHCs). The sentiment, exacerbated by leaner economic times, grows out of the ability of in-state companies to reduce their tax burdens by setting up DHCs.
An oversimplified scenario might go something like this. ABC Company, headquartered in State X, pays significant corporate taxes to that state based on income generated from existing tangible and intangible assets. Like any other "person," ABC Company seeks ways to increase its net revenues/profits and reduce its tax obligation. ABC Company therefore seeks to form a holding company for the management of some or all of its intangible assets in a more tax-friendly state. Enter Delaware.
Building on its century-old plus reputation as the corporation center of the US, Delaware enacted legislation which provided that out-of-state companies could establish holding companies for intangible assets. DHCs, which are often beyond the taxing arm of a non-Delaware company's home state, are also not taxable in Delaware. In our scenario, Delaware's legal environment positions ABC Company to benefit in many ways. In addition to the predictability and security of Delaware's long-standing, internationally renowned and corporation-savvy Court of Chancery, ABC Company can minimize the often significant tax burden of the home state by shifting income from that state and/or incurring expenses such as royalty, interest and other payments made to DHCs holding the companies' patents, trademarks, trade names, debt obligations or other intangible assets.
In response, ABC Company's high-tax home state, eager to increase its tax revenues, modifies its laws in an attempt to force ABC Company to pay additional in-state tax. Some home states attempt to negate ABC Company's holding company expense deductions through the audit process, where the deductions are disallowed. Either approach could significantly threaten ABC Company's bottom-line, and jeopardize the value of ABC Company's assets and affiliates. Delaware, however, has enacted additional legislation that provides companies the continued freedom to structure intangible asset tax relief without the penalty of significantly higher taxation. House Bill No. 403, enacted on June 18, 2004, creates a new entity called the Headquarters Management Corporation (HMC). HMCs address both threats to ABC Company's tax planning structure. Following are some of the key features of HMCs:
1. Taxed on Delaware income, but at reduced rate (unlike DHCs).
2. Must provide either Investment Management Services or Headquarters Management Services or both (DHCs may only provide the former).
3. May provide these services within and outside the State of Delaware (DHCs must provide its services solely within Delaware). Income generated in another jurisdiction is taxable in that jurisdiction.
4. Have alternative tax calculations, credits and fees.
5. Could qualify for a reduction of between 2% and 99% of its Delaware taxable income, depending on the number of its employees and/or the amount of its other qualifying expenditures.
6. Could qualify, under certain circumstances, for a Delaware income tax credit of $400 per Delaware employee.
7. Can be formed from an existing entity with proper license fee and within prescribed time periods, depending on the desired year of licensing.
8. Status as HMC remains effective until HMC broadens its Delaware activities beyond Headquarters Services and/or Investment Management Services, or until terminated by the HMC.
Delaware HMCs provide companies the opportunity to continue to manage their tax obligations responsibly and in a manner that serves the best interests of shareholders, employees and the corpus itself.
Andrew T. Panaccione, CPA is President of Entity Services Group, LLC of Wilmington, Delaware, a full-service Passive Investment Company service provider. Mr. Panaccione and his Entity Services associates provide a comprehensive portfolio of services designed specifically for the implementation and operation of Special Purpose Entities, including Delaware Holding Companies. Mr. Panaccione can be reached at (302) 654-7584 or ESG@entityservices.com. The Entity Services website is at http://www.entityservices.com.