What U.S. Investors Want to Know
In the international marketplace, Nigeria has taken the spotlight in the last few years as a prime location for technology startups, with more than $1.6 billion raised in Nigerian startup funding in 2021 alone. As one of the largest hubs for technology investment in Africa, many investors are seeking ways to get involved with Nigerian startups, and that includes U.S. investors. As such, it is common for Nigerian startups to actively petition for U.S. investors with access to substantial equity and resources.
U.S. investors typically wish to know the same information – how can they invest in Nigerian startups in a way that is right for them as an investor? According to Vazi Legal, a Nigerian law firm, the best ways to invest in Nigerian startups include the following.
- Debt system, or offering capital in exchange for repayment – Since funding is one of the most common challenges for startups, investors may lend money to a startup and agree on a system of repayment over a period of time.
- Debt-to-stock investments – Like the debt system, investors may provide funds for the startup with the expectation of repayments. However, where the debt system utilizes repayment in the form of cash, debt-to-stock investments provide repayment in the form of stock shares when the startup is acquired or demonstrates an adequate funding round.
- Stock and equity investments – The most common method of startup investment, investors are given equities and shares in return for their investment. The idea is that the equities and shares yield substantial returns as the company grows, and as an investor receives equities from the company, they may then be able to exercise a vote and share in company profits.
- Dividend investments – As a common practice among larger startups, investors may buy shares of stock that pay annual dividends.
How U.S. Investment Affects the Taxation Concerns of Nigerian Startups
Now that you’ve found potential investors for your Nigerian startup, it’s important to know the tax implications and impacts when doing business in the United States. Here are a few practical considerations as you prepare to seek out U.S. investors for your Nigerian business.
- Understand the U.S. tax implications for common investment options mentioned above – The most common structure for attracting U.S. investors is the corporate structure. Typically, the founders of a startup form a U.S. holding company most often in the state of Delaware (see below), and then transfer the Nigerian startup and all other foreign subsidiaries to the U.S. company, creating what some call a U.S. “sandwich” structure. Keep in mind that while the goal of attracting U.S. investors can be achieved through this structure, it could come with a hefty tax bill and complex filing requirements. Additionally, the after-tax foreign earnings may be subject to several layers of income and withholding tax across jurisdictions as earnings are distributed from the foreign subsidiaries to the U.S. holding company, and then ultimately out to the founders, owners and investors.
- Know the federal (and state) corporate tax rate – Currently, the U.S. corporate tax rate is 21 percent on worldwide taxable income. If there are any operations or an employee working in the United States, then the company may be subject to taxes in that particular state, which could range from 0 percent to 9 percent. As mentioned previously, most foreign structures choose to set up their U.S. holding company in Delaware. In this instance, there will be an annual registration fee in Delaware, but generally, no separate state income tax filing requirement is needed if there are no other operations in the U.S. other than the holding company.
- Understand withholding tax rates on certain types of income – There is currently no double-tax treaty in force between the United States and Nigeria. In fact, there are currently only a handful of double-tax treaties that are in force between the United States and certain countries in Africa (Egypt, Morocco, South Africa and Tunisia). Therefore, the withholding tax that is charged against certain types of income will not be granted treaty relief. The United States charge a flat 30 percent withholding tax on certain types of U.S. source income that are fixed, determinable, annual or periodical (FDAP) and is not effectively connected income. These types of income most commonly include interest, dividends, royalties, rental income, etc. Depending on the investment structure, if a loan is made between the founders/investors and the U.S. holding company that is then loaned to the underlying foreign subsidiaries, interest payments to any non-U.S. investor is generally subject to the 30 percent withholding tax unless reduced by a treaty. Additionally, any dividends that are paid out to non-U.S. investors are also subject to the 30 percent withholding tax unless reduced by a treaty. Therefore, interest or dividends paid out to Nigerian founders from the U.S. holding company will be subject to the 30 percent withholding tax as there is no treaty between the United States and Nigeria. Nigeria also charges a 10 percent withholding tax rate for payments of interest, dividends and royalties.
- Understand your filing requirements – Assuming the corporate structure mentioned above, the following are generally required to be filed to report the activity of the global operations:
- Form 1120, U.S. Corporation Income Tax Return
- Form 5472, Information Return of a 25 Percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (filed with Form 1120)
- Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations (filed with Form 1120, and reports each foreign corporate subsidiary)
- Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs) (filed with Form 1120)
- Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation (filed with Form 1120)
- Form 1118, Foreign Tax Credit – Corporations (filed with Form 1120)
- Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI) (filed with Form 1120)
- Form 114, Report of Foreign Bank and Financial Accounts (filed separately to Financial Crimes Enforcement Network (Fin Cen))
- Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding (filed if any FDAP is paid)
- Form W-8 Series, Certificate of Foreign Status of Beneficial Owner for U.S. Tax Withholding and Reporting (kept on file)
The U.S. corporate filing deadline is four months and 15 days after the taxable year-end of a corporation, or April 15 for a calendar year taxpayer. The United States allows a six-month extension of time to file, but the estimated tax liability is required to be paid in by the original tax deadline, or penalties and interest may be assessed for underpayment of tax, as well as for returns filed late. Form 1042-S is due by March 15.
- Choose the right jurisdiction in the United States – U.S. tax law includes tax requirements at the federal, state and local levels. While federal tax compliance is universally applied, state and local tax (SALT) compliance can vary based on the state, county and even towns and cities. Therefore, it is essential to research tax requirements (reporting and payment) for the location you’re considering. To continue with the example of Delaware, many investors and capital firms prefer companies incorporated in this state because of its corporate income tax exemption, and privacy protection laws and also because U.S. citizenship or residency is not required to incorporate in Delaware. Despite these provisions, businesses must still pay an annual franchise tax and filing fees, and they are also required to settle any legal disputes in the state of Delaware only.
The Right Advisor Can Help
The complex tax structure in the United States can be daunting when determining whether to enter the U.S. market; however, the benefit of attracting U.S. investors could far outweigh the nuances of the U.S. tax laws.
The outline above is not an exhaustive list of tax considerations, structure options or corporate tax filing requirements. As you determine when, where and how to seek U.S. investors for your startup, or when establishing a business presence for your company in the United States, the right advisor can help you navigate the complexities and nuances of U.S. tax law.
Windham Brannon’s team of international tax professionals is ready to assist you in the growth of your business and in maintaining your tax compliance and reporting requirements. For more information, reach out to Brandi Samuel.
