Hanhai Start-Up UniversityDoing Business Internationally – A Guide For Emerging Technology Companies

October 14, 201412:30pm

James C. ChapmanPartner

Introduction

• Overseas expansion is a consideration from the point of start-up onwards.

• Each country has its own laws, currency, language, taxes and culture.

• Presentation will cover – • Tax Issues

• Talent

• Intellectual Property

• Fraud

Tax Issues

How should the entity be structured?• What form should the entity take?

•  A pass-through entity (LLC, partnership, S Corporation) - items of income and loss pass through to the stockholders. Personal US tax rate is 39%.

•  Corporation

•  Use of foreign subsidiaries

Where should the entity be based?

• United States

• Europe

• Low/no tax jurisdiction - BVI, Cayman, Hong Kong

Investor Expectations

• What jurisdictions are acceptable to investors?• Cayman, BVI?

• Hong Kong?

• Ireland?

• Isle of Man?

• Luxemburg?

• Switzerland?

Timing

• Initially - Upon formation, select a foreign jurisdiction

• Some future date - pros and cons

Tax Regimes – Taxing rights based upon• Nationality - Based upon citizenship and

residency. US taxes citizens and residents on all worldwide income regardless of where they do business.

• Territoriality -Taxation depends upon the location of people, property, income or wealth. A country using this system imposes taxes upon business profits of a non-resident earned within its borders.

Avoiding Double Taxation

• Multiple countries assert taxing rights over the start-up each claiming the start-up is a resident.

• Multiple countries asserting taxing rights over a transaction both asserting that income from the transaction is earned in and should be taxed by each country.

• Split tax assertion over a party and the transaction.

Methods

• Uni-lateral • Some countries do not tax foreign income of their

citizens and residents or corporations.

• Other countries offer a credit for foreign taxes paid, i.e. US Foreign Tax Credit.

• Bi-lateral • Tax treaties provide reduced tax on certain types of

income.

US Approach

• Elimination of tax -The foreign tax credit provides a direct credit for foreign taxes against US tax liability.

• Deferral - Tax of earnings of controlled foreign corporations (subsidiaries) are not taxed until dividends/ distributions are made to the US parent or when gain realized on the sale of stock of a corporation.

• Reduction of Tax - Special deductions and exemptions are issued such as the exemption for certain earned income of qualified US citizens or US residents living abroad.

• Treaties - Agreements among nations where the US relinquishes or limits certain taxing rights.

Talent• The use of employees and contractors in foreign

countries is complicated.

• Employment-at-will - This does not exist in Europe and China

• Employees in most foreign countries are difficult to terminate, are aware of their rights and well-known for using them.

• Stock Options - Although this is vital in the US for recruiting top talent, incentivizing employees in many foreign countries with stock options is neither expected nor advisable.

• Hiring an employee establishes a presence in the country where the employee is located.

Intellectual Property

• Trade Secrets• The biggest threat to technology in countries such

as China, Russia, Brazil and other emerging markets is theft by employees.

• Trade Secret Protection Plan - Legal Requirements• The laws of most jurisdictions require that the trade

secret owner undertake actual efforts that are rigorous enough to force another to use improper, unethical, or illegal means to discover the trade secret.

Intellectual Property (cont’d)

• Particular Measures

(1) the nature of the trade secrets;

(2) the nature of the industry; and

(3) the nature of the company.

Objectives of a Trade Secret Protection Program(1) it should prevent misappropriation of trade secrets, and

(2) it should be sufficient to convince a court to enforce a company’s right in its trade secrets against misappropriation.

Security Measures

• Physical security measures include: locks on entrances, buzzer locks on doors to sensitive areas; visitor sign-in and screening and use of identification badges; exclusion of the general public; shredding of sensitive documents; physically separating work areas from the rest of the facility; locking files; and using computer access codes, screen savers, and other security for computer networks.

Confidentiality Procedures

• Confidentiality procedures fall into four major categories:

(1) document control;

(2) procedures directed at computer use;

(3) procedures directed at employees; and

(4) procedures directed at third parties outside of the company.

Patents

• A patent, in most countries, has a 20-year term. That is, after a patent issues in a country, it prohibits anyone other than the patent owner and its authorized entities from practicing the invention as defined by the claims in that country, until 20 years after the filing of the non-provisional application.

The Economics and Logistics of Patent Filings• When and Where to File

• With high technology companies, early filing is recommended, especially after the United States became a “first-to-file” country, effective March 16, 2013. Life science inventions are treated differently.

•  At the minimum, however, an application should be filed before the startup reaches out to potential partners and investors.

• Some countries, including the United States, require an invention made in that country to be filed first in that country. The rule does not concern the citizenship or residence of the inventor. Instead, it concerns the place where the invention is conceived. Simultaneously filing in two or more countries is a flawed approach.

• Foreign Filing License - One approach to satisfy both countries’ filing-first requirements is to obtain a foreign filing license from one country (without filing the application) and filing the application in the other country.

Patent Prosecution Timeline and Costs• United States Fees - The total government fees

from filing to grant is about $2000 for a small entity, plus other costs such as extra claim fees and late fees.

• Europe - The fees collected by the European Patent Office are much higher.

• Translation Costs - Filing in countries such as Brazil, Russia, and China involve translation costs, which largely depend on the number of pages of the patent application.

Patent Prosecution Timeline and Costs (cont’d)• Legal Fees - $5,000 and $10,000 for a law firm to

prepare a full patent application for a straight-forward invention in a simple technology area. Applications for complex technologies can be much higher (e.g., between $8,000 and $20,000). Additional legal costs such as amendments or responses to Patent Office actions cost from $1,000 to $5,000.

Patent Prosecution Timeline and Costs (cont’d)• Foreign Filings - After a first application, whether

provisional or non-provisional, is filed, there is a 12-month window for international filing. Other than a small number of non-PCT countries and regions (e.g., Taiwan, Pakistan, and Argentina), such international filing deadlines can be met by filing a PCT application. Upon filing of the PCT application, the applicant then has 30 months (counted starting from the filing date of the first application) to file in each individual PCT member country.

Fraud

• US Foreign Corrupt Practices Act

• General Provisions• The Foreign Corrupt Practices Act (“FCPA”) was passed in 1977 in

response to the bribery of foreign government officials by U.S. companies to obtain business overseas. The FCPA includes two key components: anti-bribery provisions and recordkeeping and internal controls provisions.

• The anti-bribery provisions of the FCPA prohibit corrupt payments (or offers, promises, or authorizations of payments) of anything of value to foreign officials to obtain or retain business, or to direct business to any person.

• The accounting provisions of the FCPA require issuers of U.S. securities to make or keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer. As a result, financial controls must be adequate to protect against off-book accounts and disbursements and other unauthorized payments.

Violations and Penalties

• Criminal liability under the FCPA requires a “knowing act.” “To know” in the context of the anti-bribery provisions requires that a person or company has actual knowledge or a “firm belief ” that improper actions have occurred or are “substantially certain” to occur. Conscious disregard or “willful blindness” is no defense to a charge of violating the FCPA.

• Failure to comply with the FCPA can result in severe penalties.

Violations and Penalties (cont’d)

• Anti-bribery provisions, individuals face criminal fines up to $250,000 and imprisonment up to five years, and companies may be fined up to $2 million for each violation.

• Violations of accounting provisions, individuals face criminal fines up to $5 million and imprisonment up to twenty years, and companies may be fined up to $25 million for each violation. • Both companies and individuals are also subject to civil fines.

• U.S. Government can demand disgorgement of profits gained through any acts that violate the FCPA.

• The internal investigations necessary to bring a company back into compliance are costly and time consuming.

Key Aspects of the Anti-Bribery Provisions• Who is covered by the FCPA - Individuals and

companies can find themselves within the jurisdiction of the FCPA based on nationality or territorial jurisdiction principals.

• In addition, U.S. parent companies may be held liable for the acts of foreign subsidiaries if the parent exercised control or direction over the subsidiary. Further, any U.S. companies or nationals acting on behalf of a foreign subsidiary would fall under the FCPA’s jurisdiction.

Key Aspects of the Anti-Bribery Provisions (cont’d)• Who is a “foreign official” - The FCPA prohibits

payments to “foreign officials” and foreign political parties, including officials and candidates of those parties.

• What is an improper “payment” or “gift” - The FCPA prohibits paying, offering, promising to pay (or authorizing to pay or offer) money or anything of value. The focus is on the purpose of the payment instead of the particular duties of the official. The person making or authorizing the improper payment or gift must have “corrupt” intent and the payment or gift must be intended to cause the recipient to misuse his or her official position.

Key Aspects of the Anti-Bribery Provisions (cont’d)• Responsibility for local agents and partners - The

FCPA prohibits corrupt payments through intermediaries. It is illegal to make a payment to a third party while “knowing” that the payment will go, directly or indirectly, to a foreign official. The same broad reading of “knowledge” and “official” that are discussed above also apply to this prohibition.

•  FCPA Compliance Program - To prevent FCPA violations, U.S. companies should establish a comprehensive FCPA compliance program to ensure compliance with the statute.

Jim is a corporate and securities lawyer focusing on start-up and emerging publicly traded and privately held companies looking to expand domestically and internationally and the venture capitalists, private equity groups and angels that invest in them.

He has been involved in approximately 250 mergers, acquisitions and finance transactions and is the author of approximately 50 articles on issues related to raising venture capital, mergers and acquisitions, start-ups, doing business in China and other topics.

Jim has been recognized by Legal 500 as one of the best lawyers in the US for mergers and acquisitions and was named one of the Top 25 Clean Tech Lawyers in California by the Daily Journal.

James C. Chapman, Partner Bingham McCutchen LLP james.chapman@bingham.com