THE DECISION TO TRADE PART II

When goods were first traded between the two areas, they exchange goods, so many minerals or barrels of wine for so garments. But as the years passed they had began to exchange goods for currency. At first the societies agreed that Tropicana pello would be worth one Westerns dollah. They also agreed that each government would support its currency by buying its own currency when the other nation wishes to sell. For example, if West accumulated a surplus of pellos beyond what it needed, the Tropicana Central Bank would buy them back. But what would they buy with if they did not have dollahs? They agreed to use gold, which was a very scarce commodity mined to about the same degree in each nation. It was very hard to find in the ground, and had long been highly prized by both nations. This currency arrangement worked for a number of years, but Tropicana was concerned that its gold reserves were diminishing. Trade was favoring West and it seemed that whenever there was some accounting to be done, it was an exchange of surplus pellos in West for Tropicana gold reserves. Tropicana had what they called an unfavorable trade balance.

One Friday afternoon the Tropicana government announced that they were devaluing their currency, that they would now give two pellos for each dollash. West and its producers did not like this. West officials said it was a "beggar by thy neighbor" policy, that it attempted to correct a domestic problem by causing harm to one's neighbor. Immediately goods from Tropicana became more attractive to buyers in West, and some goods from West were now too expensive for Tropicana buyers to consider. But over time, West became more efficient and imbalance in its favor occurred once again. This time Tropicana did not devalue. It was nearly out of gold. It decided that it would no longer exchange gold at a fixed rate for its own pellos. And it would not support the pello. It would allow the currency to float, and if there was no confidence in the pello, it would drop in value compared to the dollah. That is what began to happen. The pello had become a "soft" currency. The dollah was "hard".

Sellers in West now wanted only Western currency for their goods. Tropicana pello were not worth anything in West. Western workers making goods to export to Tropicana would not accept pellos. They could not longer take the pellos to the Western bank and be assured of receiving dollahs in exchange. And of course they had to buy their food and other items with dollash. So when a Western seller agreed to sell to Tropicana buyer, the buyer was required to obtain dollahs. Dollahs were available from the Central Bank of Tropicana, but often the supply was low. Sometimes the Tropicana buyer received dollahs for selling goods to West. It may have seemed strange to some observers, but Tropicanos were more willing to accept Western dollahs for the sale of Tropicana goods, than were Westerns sellers willing to accept Tropicana pellos for the sale of Western products.

After a couple of years the Bank of West discovered that it had many pellos which it had received from its producers, who had exchanged the pellos for dollahs. One day the Central Bank of Tropicana said it did not have any dollahs to give to the Bank of West in exchange for the pellos the latter bank had accumulated. There had never been such a problem before. So the government of West began to loan dollahs to the government of Tropicana. In time the amount of dollahs owed by Tropicana to West became very high, and Westerns were concerned that they might never be paid. Some Tropicano politicians suggested that the nation should default, but most believed that would be very harmful to the country and that extensions should be sought for paying the debt. West agreed, but demanded that Tropicana take certain steps to diminish the prospects that the same problem would arise in the future.

THE DECISION TO TRADE PART I

Once up the time, three societies began to emerge in the different locations on the planet. I am going to call them West, Tropicana and Aglaia.

In West there were reasonably good natural resources. The climate was temperate and the people quite industrious and independent. In West there had been an allocation of the society's resources on the basis of each indidividual's efforts. Some of the people worked for others, and were paid of their services. Some became quite wealthy, and others poor. But the society made everyone contribute some of what they produced to assist those unable to work. No one in West had ever ventured beyond its ocean borders.

South of West several hundred of miles lay Tropicana, a large island nation stretching across the middle of the planet. It had many natural resources, more than West. The climate was extremely hot. Most of the population was involved with small scale agriculture. A few persons had accumulated considerable wealth, but Tropicana was mainly a poor island where more people worked hard to survive. There was much disease in Tropicana, far more than in West. Families, rather then leaders of the society, tended to provide for those who were unable to provide for themselves. But there were more poor than in West. As in the case of West, no person in Tropicana had ventured beyond the island.

To the east of West, on the third major land mass, was Aglaia. The climate and amount of natural resources were similar to West, but the society's distribution of resources and ownership of property was very different than in either West or Tropicana. In Aglaia, everything was owned collectively by the group. Each person was entitled to receive what was needed to live, and each was expected to produce according to his or her maximum capacity. The mass of the population existed with adequate food, housing and medical care, with on one having very much more than anyone else. But the government elite seemed to live quite well. Aglaians were as little travelled as Westerns and Tropicanos; none had ever ventured beyond Aglaia.

As the people of West became more affluent, they had time to devote to activities other than providing for necessities. Culture and thought occupied the time of a number of Westerns. New ideas of exploration caused small delegations to be sent across the oceans in search of what lay beyond. When a group of Westerns arrived in Tropicana, they were surprised to discover a population living in much less affluence than in West.

Tropicanos were very interested in the better quality garments and farm instruments possessed by the Westerns. They asked if they might obtain some of them. It took Tropicana five days to make a garment, but the same garment of better quality could be made in West on something Westerns called looms in only a half day. At first the Westerns offered to give the Tropicanos some garments; both people were quite friendly towards each other. The Tropicanos accepted several, but said they would like to be able to obtain many more for their people. West would have to increase its production of garments to satisfy the demand of Tropicana. If they did that they would have to stop producing something else. So they talked to Tropicanos. The Tropicanos said that although the tools of the West were very useful in design and quality, the metal was very soft and they discovered that Western tools did not last long. The Westerns agreed that was a problem with their tools. The Tropicanos showed the Westerns some of the minerals found in many places on their island in great abundance. One mineral was very hard and after some experimentation the Westerns learned that they could add it to their metal and make very strong tools. So the Westerns had found something to receive in exchange for their garments. They would take so many kilos of the Tropicana mineral for each garment. And so the nations began to trade. West received something it did not have and Tropicana received something it had not been able to produce as well as West.

Labor costs of production might have equalized in the two societies, but people of West were reluctant to move to Tropicana, and Tropicanos generally felt the same about moving to West. Furthermore, each nation had placed limits on immigration. This had a tendency to preserve labor differentials in the production of goods.

Later the two societies discover that Tropicana made a wonderful wine, and they did it with much less labor than the wine produced in West. It took West ten days to produce a barrel, while Tropicana could do the same in two days. It seemed appropriate for West to trade some of its garments for Tropicana wine. West had a "comparative advantage" in producing garments, Tropicana in producing wine. And so they traded more. And they began to to discover that West produced some other items more efficiently than Tropicana, while the latter produced nearly as many goods more efficiently than West.

One of the items which West produced more efficiently was dishes. The firing kilns were very advanced in West. There was also a dish industry in Tropicana. It was owned by relatives of some of the leaders. The dish producers said that if Tropicana imported dishes from West, the Tropicana producers would go out of business. They also said that now that the two countries traded, the Tropicana dish producer would learn how to make better dishes and soon would be able to compete with the Westerns dish producers. So the Tropicana leaders said to the West, "We will not allow your dishes to come into our country because we must protect our infant dish industry." The Western dish producers were not happy. Nor were the leaders of West. They said the two societies should trade all goods with no restrictions. They referred to this as free trade. But the Tropicanos pointed out that the Westerns would not allow Tropicana boats to be sold in West. West official responded by saying that unlike the dishes, boats were necessary for survival of West and it must protect that special industry. Westerns asked Tropicana when it thought the infant dish industry would mature, and be able to compete with West. Tropicana thought it would take ten years and suggested that until that time no Westerns dishes would be imported. When Westerns pointed out that their dishes were finer in quality than the Tropicana's, the leaders of Tropica suggested that some would be allowed in, but that they would establish a quota of so many thousand per year. Some critics in Tropica suggested that would allow the government elites of Tropica access to the finer dish. But after thinking more about the idea, Tropica decided that it could raise some needed revenue by placing a tax on imported dishes. They also learned that when news of quotas reached West, various Western dish producers began arguing for guotas allocations. So Tropica discarded the idea of quotas and placed a tariff of four pellos on each Western dish. They estimated that the same number would entered by paying tariff as would have with the quota, but that using a tariff would raise revenue. The revenue was needed because the nation was trying to build roads and ports to help its trade. But it seemed to be buying more goods from West than Westerns were buying from Tropica. Westerns debated whether it ought to retaliate against these new tariffs, but it did not. Its leaders wished to pursue free trade. It seemed inevitable, however, that trade would not really be free, but that officials from these countries would create various regulations to limit trade when limitations were believed to be in the best interests of their nation.

To be continued.

FORMS OF FOREIGN BUSINESS ENTITIES

Posted by Norka M. Schell

Materials extracted from
International Trade For The Nonspecialist
Second Edition
By Paul H. Vishny
And Internatioanl Business Transactions
Third Edition
By Ralph H. Folsom, Michael Wallac Gordon and John A Spanogle, Jr.

When a company makes the decision to establish a presence abroad, it faces numerous questions about the legal form of that presence. The company's presence may be as simple as a U.S. - based sales representative working out of her hotel room, or it may be more complicated, involving the formation of, or acquisition of an ownership interest in, a legal entity under the laws of the foreign country. On either end of the spectrum, it is critical to have competent advice as to the legal consequences of the presence abroad.

Virtually all countries have forms of business entities that are similar to corporations and limited liabilities companies in the United States, but appearances can be deceiving. For example, in some countries, there are limitations on the percentage of shares that any single shareholder may vote. Whereas U.S. companies formed under the new limited liability company laws may be non-taxable entities, in most other countries limited liability companies are, like corporation, taxable. Many countries have minimum capital requirements for certain types of legal entities. In some places, the higher capital requirements, more difficult registration requirements, or other factors involved in the formation and operation of a particular form of business entity will give the impression that a company using that form has greater substance and stability than a company using another form.

Establishing a presence and conducting business abroad means acting under the laws of the foreign jurisdiction, and thus requires a thorough understanding of the applicable local laws. Company laws and commercial laws and practice are unique in each jurisdiction. In most cases, on-the-ground legal representation is critical.

The threshold question in establishing a place of business in a foreign country is the form in which business will be conducted. The most popular forms for U.S. companies doing business abroad are branch offices and corporate subsidiaries. But it may be that a liaison office, instead of a branch, or a joint venture, rather than a subsidiary, would be more appropriate in a particular situation.

The choice of legal entity often depends largely on: (1) the proposed activities of the foreign office and whether local law in the foreign country imposes any restrictions on the foreign company's activities through a particular legal form; (2) whether the legal form provides limited liability to the foreign company; (3) whether the legal form results in taxation of the foreign company, and the degree of taxation of the local presence, in the foreign jurisdiction. The taxation issue may be the most complicated, depending on U.S. tax law, foreign tax law, and the tax treaty between these countries, if any.

Liaison Offices
Some countries allow a limited business presence known as a liaison office, which may or may not be required to be registered with the local authorities. A liaison office is not a legal entity separate from the foreign company, but is an office (or perhaps a single employee) through which the foreign company may engage in certain limited activities in the foreign country. Local laws governing these types of offices should be consulted to determine the permitted activities.
Whether the activities of the liaison office are subject to taxation in the foreign jurisdiction depends on the local tax law and the tax treaty between the countries.

Branch Offices
A branch office is an extension of the foreign company constituting a direct legal presence in the foreign jurisdiction. A branch typically may conduct the full range of business on behalf of the foreign country. Because this legal presence will expose all of the assets of the foreign company to claims arising in the foreign country, many companies attempt to limit their liability by forming a subsidiary in its home country, and having that entity establish the branch office in the target country.

Establishment of a branch office will generally expose the foreign company to taxation in the foreign country with respect to that portion of its income that is sourced in the foreign country. Taxation of the branch office may be minimized by forming a subsidiary to establish the branch.

Subsidiaries
A subsidiary is a legal entity separate from the foreign company. A primary objective of establishing a separate entity is to limit the liability of the foreign company. Depending on the laws of the foreign jurisdiction and the form of legal entity used, the liability of the parent company is generally limited to its capital contribution to the subsidiary. However, "piercing the corporate veil" is not only a United States concept. A wholly-owned foreign subsidiary that is thinly capitalized, controlled and managed by its parents, and serving the business interests of its parent may be deemed, for liability purposes, to be part of a single enterprise with the parent, subjecting the parent to the liabilities of the subsidiary.

A subsidiary with limited liability will almost certainly be subject to taxation in the foreign jurisdiction.

A company that choose to establish a foreign subsidiary may have the option of purchasing an "off the shelf" company rather than forming a new entity. In many countries, the incorporation process is lengthy, with the necessary approvals taking anywhere from six weeks to six months.
Joint Ventures
A joint venture entity may be established to penetrate a foreign market, using the good will and experience of an established local company and/or complementary technology or capacities, to promote the products and services of the foreign investor, or to engage in an entirely separate business. A joint venture has to advantage over a wholly-owned subsidiary of spreading costs and risks, but it often entails complicated issues of management and control and may be subject to greater regulatory requirements.

Forming and operating a joint venture is generally more complicated that forming and operating a wholly-owned entity. In addition to the documents usually required for the formation of a subsidiary, a joint venture requires the development of a joint venture agreement. Such agreement covers issues typically addressed in a domestic shareholders agreement, including restrictions on transfer, buy-sell arrangements, and especially management and control provisions. In some countries, this document is required to be filed along with other registration documents. Joint ventures often also face greater regulation than do wholly-owned entities, such as notification and approval requirements applicable under antitrust laws when competitors enter into a joint venture.

Establishing a Presence Abroad

Posted by Norka M. Schell
Material extracted from International Trade For Nonspecialist
Author Franklin C. Jesse, Jr.

You have decided to establish your business presence in a foreign country with one or more employees. There are three basic choices as to the legal status of that foreign operation that you may consider:

Choice (1) A Liaison or Representative Office;
Choice (2) A Branch of the United States Company; or
Choice (3) A Subsidiary of the United States Company.

A liaison office is an office whose activities are limited to promotional and liaison work. The number of employees is usually limited to a few.

In countries that require prior approval before "doing business," a liaison office can often be established without approval, since it does not have official status.

The activities of a liaison office usually must be limited to general promotion; storing or displaying merchandise; advertising; purchase of goods or the collection of information, conducting market research, and the like. Booking orders, opening letters of credit, manufacturing, and distribution of products would create "permanent establishment" or constitute "doing business" and would thus destroy the liaison office status.

Double tax treaties usually exempt these offices from income taxation by the host country.

Branches or Subsidiaries: When the level of foreign activity exceeds that permitted for liaison, a branch or subsidiary or the United States company must be established in the foreign country. Registration is usually required regardless of the form chosen.

Many countries provide for more than one kind of corporation or company having limited liability. The choice of corporation is between a closely held corporation and a "public corporation" form.

A closely held corporation is usually less expensive to organize, easier to manage, and subject to less reporting and labor restrictions.

A "public corporation" does not have to be publicly held. It is somewhat more costly to organize and administer, and it is sometimes subject to greater regulation in the areas of reporting and labor relations.