|Sunday April 11th 2021|
How Delaware became the sexiest place in America to start a company
Nearly 1.5 million companies are incorporated in Delaware. How did this tiny state become a mecca for business?
BY Zachary Crockett
Take a look at a company’s registration documents and you’ll see the address in a good way 1209 North Orange Street.
This nondescript office building spans less than a block in Wilmington, Delaware and is the official founding address of more than 285,000 companies from around the world.
On the surface, there’s no reason why Delaware – home to blue chickens and Civil War monuments – should be a corporate haven. It is the second smallest state in America and the sixth largest with a population of just 986,000.
Almost 1.5 million companies from all over the world are included, including 68% of all Fortune 500 companies. Among them:
How did Delaware become an unlikely Mecca for American corporation? And why do so many companies park there?
The story begins in New Jersey over 100 years ago
At the beginning of the 19th century, every company had to be registered (legally established) in the state in which it was doing business – and obliged to use the tax codes of that state.
After industrialization, big companies like Standard Oil and the Whiskey Trust began to consolidate broken markets. To counteract this, many states have passed laws aimed at regulating monopolies through high taxes.
But New Jersey saw an opportunity to look after the industry.
In 1891 the Garden State passed an extremely generous corporate tax law that would “allow companies to do business at will.” By founding there, a company based in another state could save huge amounts of taxes and enjoy benefits such as unlimited market expansion.
A flood of conglomerates accepted the offer, and New Jersey made so much in taxes that it was able to pay off all of its national debt.
Other states were under pressure to encourage businesses to stay and offered their own lenient corporate tax policies.
In this so-called “Race to the Bottom”, Delaware emerged victorious.
The Delaware General Corporation Law, enacted in 1899, “minimized restrictions on corporate action” and pledged to maintain the most hospitable business enclave in the country – a place where corporations could frolic in the open fields of capitalism without incurring income tax. bureaucratic policing and shareholder disputes.
A copy of the 1899 Delaware Corporation Law (Widener University, Delaware Law School)
In the decades that followed, many other states (including New Jersey) declined a bit of their leniency towards companies.
But Delaware did not withdraw.
The state is still the start-up zone of choice for companies. The climate is so favorable that international companies are also looking for peace and quiet there.
What exactly is it that makes Delaware so appealing?
The Delaware Gap
For example, let’s say you run a tennis ball company in California with net income of $ 100 million a year.
In California, you pay state income tax (8.84% of net income) in addition to federal corporate income tax rate of 21% – and possibly an alternative minimum tax (6.65%).
However, by incorporating in Delaware, you can probably save millions in taxes with something called the “Delaware loophole. ”
In Delaware, intangible assets – think brands, copyrights and leases – are tax free. Companies often transfer these assets to a Delaware subsidiary and pay their own subsidiary for the rights to use those assets. That saves you money on both ends:
- The company can write off these payments in its home state, dramatically reducing its tax burden.
- The company is not taxed on its Delaware business.
So if you pay your Delaware subsidiary – let’s call it Tennis Ballz, LLC – $ 80 million for the rights to use your own copyrights, you could potentially increase your taxable income from $ 100 million to $ 20 million and save millions in taxes.
As any Delaware tax attorney will attest, the system is a little more complex. However, the process can generally be simplified as such:
Zachary Crockett / The Hustle
The most famous real life example is from Toys “R” Us.
Twenty years ago, the national chain formed a Delaware subsidiary – Geoffrey LLC – and paid the subsidiary an annual fee for the rights to use its own name and mascot. In 1990 alone, these payments were able to evade South Carolina state taxes by $ 2.8 million (now $ 5.5 million).
Incorporating in Delaware brings a number of other tax breaks, including:
- No state corporate income tax
- No sales tax
- No tax on interest / other investment income
- No VAT
- No personal wealth tax
- No inheritance tax
Instead, a company only pays a franchise tax ($ 175,000 to $ 180,000, depending on size), as well as small agent fees, annual reports, and registration fees.
For the state of Delaware, these small fees account for up to 41% of total state revenue. In 2019 they totaled together $ 1.4 billion.
For other states, the deal isn’t as sweet: the Delaware loophole has been estimated to cost other states up to $ 9.5 billion a year in collective tax losses.
But taxes aren’t the main benefit of incorporating in Delaware: most companies are included for privacy and legal reasons.
Company privacy and expediency
When a company wants to be incorporated in Delaware, it works through a registered agent – a person in the state who acts as an intermediary, collects records, and provides the company with a physical address.
There are two major registered brokerage firms in Delaware:
- CT Corporation (1209 Orange Street) is home to more than 285,000 companies including Walmart, Apple, and Coca-Cola.
CSC (2711 Centerville Road) is home to companies such as McDonald’s, Amazon, and Facebook.
This nondescript office building at 1209 North Orange Street in Wilmington, Delaware is home to approximately 300,000 companies from around the world – but none of them are based here. (Wikipedia)
In Delaware, the incorporation process can take time less than an hour to complete – and the state does not require companies to disclose the names of officers and directors where permitted anonymity.
“Delaware is the state that needs the least amount of information,” a Delaware business registration agent told the New York Times in 2012. Delaware has the world’s most secretive companies and is the easiest to start with. “
Carl Levin, a retired Senator from Michigan, said it was easier to start a business in Delaware than getting a driver’s license.
This practicality, coupled with the appeal of anonymity, has drawn a number of seedy businesses to Delaware in recent years:
- Viktor Bout, a Russian arms dealer once known as the “merchant of death,” had nearly a dozen Shell companies in Delaware.
- Tim Durham used a Shell company in Delaware to run a $ 207 million Ponzi program for more than 5,000 elderly Americans.
- Carl Ferrer used a Delaware shell company to host the sex trafficking website Backpage.com.
- El Chapo used a Delaware LLC to hide antitrust drug money.
Of course, the vast majority of Delaware corporations and LLCs are legitimate businesses. And for these companies, the courts are a big draw.
A favorable court system
Delaware has a so called Court of Chancery.
Here company lawsuits are settled by the court judges who specialize in company law, rather than by juries. While the average civil lawsuit in America can take 2-3 years to resolve, the Delaware process is far more convenient.
The law enforcement officers of the Delaware Court of Chancery oversee state commercial litigation (Delaware.gov).
As Priceonomics reported, the former Chief Justice of the Federal Chancellery once said: “If you need an answer within four days, you will get an answer within four days. [Delaware’s] The Supreme Court will turn heaven and earth itself to give you an appeal answer. “
Many legal experts claim that these courts are mostly cheap for companies – especially when it comes to shareholder disputes.
Despite its favorable climate, Delaware’s status as a domestic tax haven is widely debated.
However, there is no denying that the state is part of a broader trend in which the US has turned away from financial transparency over the past few decades.
According to the Tax Justice Network, an advocacy group that pursues tax avoidance, the US is now the second largest tax haven in the world, just behind the Cayman Islands.
America’s so-called “wealth defense” industry – a system of shell companies, secret cash caches, and tax avoidance mechanisms – has increased the nation’s income inequality.
Efforts to correct this are ongoing.
A new federal law passed in late 2020 banned anonymous Shell companies in the US. However, the full picture of how this could affect Delaware remains unclear.
In the meantime, have 68% of the Fortune 500’s mailing address available for any concern.
Share and discuss this story on:
How did you like today’s story?