For new investors on Saipan, there are many decisions to be made. Where will you open your business? Who will you hire? How will you find customers? But one of the first decisions that you will have to make is, what form of a business should the new business be? This article deals with two options an investor has in the form for the business to choose: the classic corporation, or the limited liability company. 1
Overview of Business Formation Regulation
Businesses formation is regulated by the CNMI Government.2 The Legislature has enacted statutes that both allow for various business structures and restrict what can be done. The Office of the Governor through its agencies and the Attorney General enforce the statutes. The agencies and also the Attorney General issue regulations that clarify the statutes and set forth procedures for compliance. A new investor must comply with the statutes and regulations that apply to their form of business and the business activity they intend to engage in.
Not long ago, when attorneys spoke about corporations, there was pretty much just one type of corporation to speak about. It had shareholders, who elected a board of directors, that in turn elected officers to oversee management, and the profits of the corporation were distributed to the shareholders as dividends. Since there was pretty much just this one type of corporation in the CNMI, we just called them “corporations.” But there were other forms of corporations. A special form of corporation that has some tax advantages is the S Corporation and we call these “S Corporations.”3 Then limited liability corporations were approved for the CNMI. We call these “LLCs” for short, but they are corporations. When you read about corporations in this article what is intended are the classic, C corporations. In this article limited liability corporations as “LLCs.”
The Classic Corporation
If the corporation incurs debts it cannot pay, the corporation is held liable, not the shareholders who own the corporation. The risk that a shareholder takes when he or she invests in a corporation is only the amount of the investment. This limitation on liability for the investor is one of the primary reasons why investors form corporations to own their businesses. The corporation is an independent legal entity owned by shareholders (a corporation is a person too).4 Corporations, in fact, do not have all the same rights as people, but for the purposes of business formation, what is important to understand is that the corporation itself, not the shareholders, directors or officers, is held legally responsible for the actions of the business. To obtain the protection from liability that corporations offer their shareholders, they must be treated as separate from the shareholder and corporate formalities must be followed. The corporation itself can enter into contracts, and to maintain its separateness from its shareholders the corporation should be the party to the contracts and those contracts should be approved by the corporation’s board and properly executed by the appropriate corporate officer. Corporations are more complex than other business structures because they have layers of administration and special tax requirements. Consequently, corporations are generally recommended for larger business undertakings that will involve a large number of investors.Corporations offer the ability to sell the ownership of the business through stock offerings. Stock offerings make raising capital to expand the business relatively easy, and also make the sale of a successful business after it is built fairly simple.
Forming a Corporation
As a preliminary matter, there is no requirement that any of the shareholders or directors or officers be United States citizens. The ownership of your CNMI company can be 100% foreign. The ownership of your CNMI company can also be by another company. Also, the minimum requirement as to the number of shareholders, officers and directors is one (1) and there is no restriction in being involved in multiple capacities. That is right, one person can be the sole shareholder, officer and director. Choose Your Name: The first step in forming your corporation is to pick a name. The CNMI Registrar of Corporations will need to verify that the name you desire is available and will not cause confusion with other, existing businesses. Your corporation’s name must end in “Incorporated,” “Corporation,” “Company,” or “Limited.” But you can use an abbreviation for the term you chose (“Inc.,” “Corp.,” “Co.,” or “Ltd.”).5 Your corporation cannot be called a “Cooperative,” or a “Credit Union” unless you comply with special provisions that relate to these forms of businesses.6 Your corporation can have a different, “doing business as,” name. It can even have more than one dba. The dba will appear on the Business License, not on the corporate Charter. Once you have picked your name and verified that it is available with the CNMI Registrar of Corporations, your corporation will be formed by filing with the Registrar of Corporations proposed Articles and Bylaws, as well as an Initial Annual Report. File the Articles of Incorporation: The Articles of Incorporation create the basic structure of the corporation and set forth its powers and any restrictions on what it can do.7 The Articles are generally very broadly worded so as not to limit the corporation later on. One key provision that you will have to decide if you want in your Articles is what are referred to as a “preemptory rights” restriction. In short, if you include this provision it will operate as a restriction on the ability of shareholders to sell their shares. Preemptory rights allows the company, or other shareholders, essentially the right of first refusal for the purchase of the shares of a shareholder who wants to sell their shares. Be sure to discuss preemptory rights with your attorney. File the Bylaws: The Bylaws set forth how the corporation will operate.8 Corporations act on major matters through meetings of their Board of Directors. The Bylaws will establish and annual meeting and provisions for special meetings. The Bylaws will also set forth the procedure and requirements for the Directors to act without the need for a formal meeting. The Annual Report: Corporations are required to file annual reports in the CNMI.9 The Initial Annual Report sets forth a summary of who are the shareholders, the directors and the officers. Each year corporations are required to file a report, updating the Registrar of Corporations on any changes that have occurred. Other documents are required to establish a corporation, such as a statement that the corporation will obtain Workers Compensation Insurance before it hires any employees (Workers Compensation Insurance is required in the CNMI). The Registrar of Corporations will review these documents to make sure what you are proposing is in accordance with the statutes and regulations that control corporate formation. The Registrar, if everything is in order, will then “charter” the corporation. Generally, the Registrar is able to act and issue a charter within three weeks of the submission of the papers, but the amount of time can vary widely. Office Location and Registered Agent. The CNMI required that all corporations have a “Registered Office and a Registered Agent within the CNMI.”
4 CMC §4331.
The Registered Agent is a person who will receive legal papers if the corporation is sued, and must be in the CNMI. The Registered Agents can be a foreign citizen but because the Registered Agent serves such an important role related to litigation it is common for attorneys to agree to act as the Registered Agent for the corporations that they form for clients. Get Your Business License: Once your corporation is chartered, the next step is to obtain a business licenses. No corporation can engage in business until it has a license.10 Businesses are required to have one general business license for each line of business for each location.11 There is a fairly simple form to fill out to request your Business License. Most, but not all Business License types have no special requirements or restrictions.12 The Registrar of Corporations will send your corporate papers over to the Business License Office as soon as the charter is issued for the Business License Office to process your request for a Business License. Generally, your Business License will be ready in ten business days after the Charter is received by the Business License Office.
CNMI corporations are required to pay CNMI taxes. Some federal taxes may be applicable as well, such as those related to employment, but generally, only CNMI taxes must be paid. When the Business License Office issues the Business License, issued with it will be a CNMI Taxpayer Identification Number used by the company to pay CNMI taxes. To open a bank account you will need the CNMI Taxpayer ID, and also a Federal taxpayer identification number. You may obtain the Federal ID online, with some restrictions. If you cannot meet the requirements to obtain the Federal ID online you will have to submit forms by mail and it will take time (possibly months) to obtain the Federal ID. You will likely need the help of an accounting firm in obtaining the Federal ID if you cannot meet the requirements to obtain it online. Unlike sole proprietorships and partnerships, corporations pay income tax on their profits. Essentially, the profits of a corporation are taxed twice – first, when the corporation pays its taxes, and then again by the shareholders when they pay their personal tax on the dividends they receive from the corporation.
Advantages of a Corporation
In summary, there are a number of advantages of using a corporation to own your business:
- Limited Liability. When it comes to debts and liabilities, the shareholders’ personal assets are protected through the use of a corporation. Shareholders generally only have at risk the amount of their investment in stock of the corporation.
- Ease of Raising Capital. Corporations have an advantage when it comes to raising capital for their business – the easy ability to raise funds through the sale of stock.13
- Favorable Corporate Tax Rate. Corporate profits are taxed at a corporate tax rate, that is generally lower than a personal income tax rate.
- Attractive to Potential Employees. Corporations can attract high-quality employees because they often offer benefits, and the potential for partial ownership through stock options, that sole proprietorships and businesses run by a partnership do not.
Disadvantages of a Corporation
There are some disadvantages to the corporate structure:
- Time and Money. Corporations can be costly and time-consuming structure to start and operate.
- Double Taxes. Corporate profits get hit with a double tax: – first, when the corporation pays tax on its profits, and then again when the shareholders pay their tax on the dividends of those profits that they receive.
- Additional Paperwork. Corporations are regulated by the CNMI, and there is additional paperwork and recordkeeping required.
The Limited Liability Company
A limited liability company (“LLC”) is a hybrid of a corporation and a partnership. The LLC offers the same protections against liabilities of the classic corporation discussed above, and also the tax advantage a partnership offers of passing the profits through to the owners so that profits are only taxed once.14 LLCs are relatively new to the CNMI.15 Because of the tax advantage, LLCs are replacing the classic corporation as the preferred structure for business ventures. The “owners” of an LLC are referred to as “members.” LLCs don’t have shareholder who own stock, they have members with membership interests. However, certificates evidencing the membership interests of the members can be issued. The members of an LLC can consist of a single member, multiple members. The members can be individuals or corporations. There is no US citizenship requirement for membership in a CNMI LLC or residency requirement. Like the classic corporation, LLCs must have a Resident Representative. And again, because of the role the Resident Representative plays when it comes to litigation involving the business, the attorney who sets up the LLC will generally offer to act as the Resident Representative.
Forming an LLC
Forming an LLC is very similar to forming the classic corporation. Pick the Name: There are two rules for naming your LLC that are the same for the classic corporation: (1) it must be different from any existing LLC;16 and (2) it must contain “limited liability company,” or “limited company,” or the abbreviation “LLC,” “L.L.C.,” “LC,” or “L.C.” The word “Limited” may be abbreviated “Ltd.” and the “company” may be abbreviated “Co.”.17 File the Articles of Organization: The Articles of Organization for an LLC are essentially the same as the Articles of Incorporation for the classic corporation.18 Create an Operating Agreement. LLC use an Operating Agreement instead of Bylaws used by classic corporations, but there is little difference between Operating Agreements and Bylaws. Both address the operation of the entity at the management highest level. Unlike the Bylaws of a classic corporations, the Operating Agreements of LLCs do not have be in writing or filed with the CNMI.19 Be aware there are two types of LLCs: Member-Managed and Manager-Managed. In short, in a Member-Managed LLC the Members manage the business (this is generally what is done for all single member LLCs). In a Manager-Managed LLC, a third party (often a related LLC) acts as the Manager. In the Operating Agreement you will provide which form of LLC you are creating.20 Obtain Your Business Licenses. There is no difference between obtaining a Business License for an LLC and obtaining one for a classic corporation.
An LLC is not a separate tax entity apart from its members. All income taxes pass through and are paid by the members as part of their personal income tax (if the members are natural persons) or as part of the entity’s income tax (if the members are entities). LLCs are generally not recognized as separate entities for taxation purposes, and LLCs with one member are considered a “disregarded entity” for tax purposes and all income flows through to the member. For multi-member LLCs, the LLC files an informational partnership tax return and issues to each member a copy of “Schedule K” to the partnership tax return, which shows each member’s distributive share of the income, and the members pay income tax on the amount as shown on Schedule K. However, the above rules do not apply where the member(s) of an LLC elect to be taxed as corporation. In that case, the LLC files a corporate income tax return, pays the tax, and then the members pay an additional tax on any distributions they later receive from the LLC. As a general rule, the following applies:
a) Single Member LLC. The sole (individual) member LLC files Form 1040CM and shows any income from the LLC on Schedule C like a sole proprietor. If the member is a corporation, it files Form 1120CM.
b) Multi Member LLC. The LLC files a Form 1065CM partnership tax return like owners of a traditional partnership.
c) Filing as a Corporation. An LLC designated as a corporation or electing to file as a corporation files Form 1120CM, the corporation income tax return and pays the income tax.
A Special Tax Concern for Single Member LLCs
An LLC owned by a member(s) who are not CNMI resident(s) presents potential problems. Because the LLC is essentially disregarded as a tax entity, and the tax liability is passed through to the member(s), each member(s) will be required to file an income tax return in the CNMI. For some foreign investors filing income tax returns in the CNMI will be difficult or undesirable as it would require the foreign investor to reveal the amounts and sources of all of their income to the CNMI tax authorities and differentiate between CNMI-source and foreign-source income. Further, the use of an LLC that elects to be taxed as a partnership is not recommended when a member is a foreign corporation. There is a requirement for a 35% quarterly tax withholding that applies when the LLC is taxed as a partnership owned by a foreign entity.22 The foreign investor member is also subject to the 30% branch profits tax imposed by Internal Revenue Code §884. The 30% branch profits tax withholding is based upon the foreign investor member’s share of the LLC profits that were not reinvested into the LLC’s CNMI business enterprise. (The 30% can be reduced to the rate set out in a country’s tax treaty with the U.S., which rate the CNMI “honors”. For instance, the branch profits tax for Chinese corporations is 10%). The foreign investor will be seen as directly engaging in business in the CNMI in the case where the LLC chooses to be taxed as a pass-through entity (partnership). To avoid this situation the LLC should elect to be taxed as a corporation. Alternatively, the investor could do business as a CNMI corporation, rather than as an LLC.
Advantages of an LLC
LLCs have the following advantages: Limited Liability: The members of an LLC are protected from personal liability for business decisions and actions of the LLC, just like the shareholders of a classic corporation are protected from personal liability for the business decisions and actions of a classic corporation.23 This means that if the LLC incurs debt or is sued, the members’ do not have to worry about losing their own property to pay the liability of the LLC. But limited liability means “limited” – the members are not necessarily shielded from wrongful acts, including those of their employees. Less Recordkeeping: An LLC’s operational ease is one of its greatest advantages. But LLCs still need to file annual reports. Overall, the CNMI requires less paperwork and is less bureaucratic than the rest of the United States, so even for classic corporations the paperwork is not overwhelming. Allocation of Profits: There are no restrictions on profit sharing within an LLC, so members can agree to distribute profits as they see fit. The profits do not have to be distributed based on the membership interest percentages if the members agree to distribute them otherwise.
Disadvantages of an LLC
LLCs have the following disadvantages: Limited Life. In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business. The remaining members can decide if they want to start a new LLC or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC if a member decides to leave the business. Self-Employment Taxes. Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.
This article is a simple overview of the two most common forms of organization of businesses in the CNMI.
|The "C" Corporation||The LLC|
|Ownership Structure Differences||Shareholders owning Stock||Members with Membership Interests|
|Management Differences||Shareholders elect Directors who elect Officers who manage the company||Can be managed by the Members, a single Member, or by a manager selected by the Members|
|Shields Investors from Personal Liability?||Yes||Yes|
|Any Lawful Purpose Allowed?||Yes||Yes|
|Strict Rules of Formality?||Yes||Not as Strict|
|Allows for Distributions of Profits Different from Ownership Interests?||Generally No||Yes|
|Preferred for Public Offerings?||Yes||No|
|Preferred for Larger Numbers of Owners?||Yes||No|
|Preferred for Better Effective Tax Rates?||No||Yes, but single member and foreign owned LLCs may need to elect to be taxed as a corporation|
Talk to an attorney to get the full details. Work with your attorney to decide which is the right fit for your planned business, or if there is a different form of organization that would be better for you. And good luck with your new business in the CNMI.
1 This article is not a substitute for talking directly to an attorney. The purpose of this article is to explain a little about corporations and limited liability companies so that when you talk to an attorney you will have a better idea what to ask about.
2 The Commonwealth of the Northern Mariana Island (“CNMI”). This includes the three most populated islands of Saipan, Tinian and Rota. It also includes the less populated northern islands in the Marianas archipelago. Guam is not a part of the CNMI. Guam is a territory of the United States unlike the CNMI that is in political union with the United States pursuant to a covenant.
3 The S Corporation is generally a closely held company that makes an election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (Title 26). Consult with an attorney or an accountant for an explanation of this form of organization.
4 Citizens United v. Federal Election Commission, 588 U.S. 310 (2010). See also, Winkler, Adam, Corporations Are People and They Have More Rights than You, Huffington Post, (June 30, 2010)
5 See, 4 CMC §4321(a).
6 See, 4 CMC §4105.
7 The basic requirements for the Articles of Incorporation are that they include: (1) the proposed name of the corporation; (2) the principal office or place of business; (3) the proposed duration (limited term or perpetual); (4) the purposes (it can be for “any lawful purpose”; (5) the powers; (6) the capitalization; (7) the name or names of incorporators; (8) the number of directors, which shall be not less than three, and proposed officers; (9) Names of directors and officers to serve until first election; (10) provisions for management, if any; (11) provisions for voting by members; (12) provisions for shareholding, if any; (13) disposition of financial surplus; (14) provisions for liquidation; and (15) provisions for amendment of articles of incorporation. 4 CMC §4103(a).
8 For the classic corporation the Bylaws must be filed. See, 4 CMC §4103(b)
9 See, 4 CMC §4693. There is a simple one page form to be filled out and filed as the Annual Report.
10 See, 4 CMC §5611(a). The statute refers to “persons” but includes corporations.
11 See, 4 CMC §5611(b).
12 Examples of a Business Licenses that have special restrictions are banking license and licenses to operate a finance company.
13 A public offering of stock is not an easy matter as Federal Securities Law may apply. Consult with an attorney before offering stock to anyone who wants to buy.
14 Unlike shareholders in a corporation, members of an LLCs are not taxed as a separate entities. Instead, all profits and losses of an LLC “pass through” the business to each member of the LLC. The members of an LLC report the profits and losses on their personal tax returns, just like the owners of a partnership would.
15 LLCs were authorized in 2004. See, 4 CMC §4801, et. seq.
16 See, 4 CMC §4806(b)(1).
17 See, 4 CMC §4806(a).
18 See, 4 CMC §4823 for the requirements for the Articles of Organization.
19 See, 4 CMC §4804. There are limitations on the operation of an LLC as set forth in the statute.
20 See, 4 CMC §4859 for a listing of the different responsibilities of the Managers.
21 This section was written by Gregory Koebel, a partner with O’Connor Berman & Banes. Greg has a LLM degree in taxation and advises the clients of the firm on tax matters.
22 The 35% withholding is required under Internal Revenue Code Section 1446 that is applied through the CNMI Tax Code. The 35% withholding is required to be done every quarter and the amounts withheld are applied to the foreign investor’s CNMI income tax liability and is accounted for in the foreign investor’s 1120F income tax return. If the withholding amount exceeds the foreign investor’s actual income tax liability, the excess withholding can be applied toward the foreign investor’s income tax liability in the following tax year.
23 See, 4 CMC §4843(a). Maintaining corporate separateness between members and the LLC is required as is following proper corporate procedures with respect to business decisions.