Myth: Delaware is the largest U.S. jurisdiction for company formation.
Fact: Delaware is the leading jurisdiction for publicly traded corporations listed on U.S. stock exchanges. More than half of such corporations (including 64% of Fortune 500 companies) have chosen to incorporate in Delaware.1 Delaware is also the leading jurisdiction for out-of-state incorporations, where a corporation headquartered in one state chooses to incorporate in another state.2
But several states have more business entities—although not more public companies—registered in their jurisdiction.3 In terms of total entity formations per year, Delaware consistently ranks among the top five states, along with Florida, California, New York, and Texas. Although nearly one million active legal entities were incorporated in Delaware at the end of 2012, 4 more than 20 million legal entities are incorporated in the United States, largely concentrated in several states. 5
For many small business entities, formation in the state where the corporation will do most of its business may be more cost-effective. But Delaware is internationally regarded as the preferred U.S. legal domicile for the majority of public corporations, for multinational enterprises that engage in merger and acquisition activity, and for complex alternative entities. For these sophisticated entities, the predictability and flexibility that Delaware’s entity statutes provide to managers and the important protections its laws and courts provide to investors are valuable and justify the cost of maintaining a Delaware entity even if these entities have no operations in Delaware.
Myth: Delaware has always been the leading domicile for public companies.
Fact: Although Delaware is today the preferred jurisdiction for incorporation among publicly traded companies,6 this has not always been the case. Before Delaware’s rise to prominence, New Jersey was the market leader for business formations, including for publicly traded companies.7 In fact, following the development of modern corporation laws in the United States at the turn of the 20th century, New Jersey, Maine, and New York were the country’s leaders in entity formation, while Delaware represented a small but growing minority position.8
In 1899, Delaware enacted a general corporation law modeled on New Jersey’s.9 More than a decade later, New Jersey enacted a series of changes to its corporate law that limited its corporation’s ability to engage in merger activity.10 These changes were pushed through the New Jersey legislature by then-Governor Woodrow Wilson following a highly contested Presidential campaign.11 This caused corporate attorneys and others to question the political and legal climate in New Jersey.12 At the time, Delaware’s corporate law had the same attractive features of New Jersey law,13 without New Jersey’s newly enacted restrictions. Delaware also offered more stability than other states, exemplified by a requirement in the Delaware Constitution of 1897 that required a two-thirds majority in each house of the legislature to approve changes to the Delaware General Corporation Law.14 Those features of Delaware’s law made it more advantageous for incorporation than other U.S. states. Since then, Delaware’s emphasis on consistency, predictability, stability and quality—further exemplified by its excellent court system—has allowed it to maintain its advantage.
Myth: Delaware has won a race to the bottom by providing companies with little or no regulation.
Fact: Delaware has a comprehensive statutory and regulatory regime to protect the public from improper behavior by business entities, just like other states.15 This regime addresses topics from the air Delawareans breathe,16 worker safety, 17 racial and sex discrimination,18 to the water we drink19 and the health of the poultry we produce and sell.20 More restrictive in some areas, less restrictive in others, it is not little or no regulation. These regulations apply to companies operating in Delaware.
This regulatory regime is not related, however, to Delaware’s corporate laws or to the decision to incorporate in Delaware. A company that chooses to incorporate in Delaware is choosing only to have its internal affairs—that is, issues like the interpretation of its certificate of incorporation, or the relationships between its stockholders and directors—governed by Delaware law.21 Incorporating in Delaware means that Delaware’s corporate law will apply; it does not necessarily mean that other Delaware laws or regulations will apply.22 A company that is incorporated in Delaware is generally subject to regulation wherever it does business, and its Delaware charter will not immunize it in any way from regulations unrelated to its internal affairs.23 For example, a Delaware corporation that operates mines in ten states (but not Delaware) would be subject to the mining-related laws and regulations of each of those ten states (but not those of Delaware),24 as well as mining-related federal laws and regulations.25 The duties its directors owe its stockholders, on the other hand, would be governed by Delaware law and can be enforced by the Delaware courts.26
Please see Delaware’s Sound and Enabling Statute to learn more about the Delaware General Corporation Law and Delaware’s Alternatives to Corporations for an introduction to other advanced modern statutes for business entities. These statutes can also be found on the State of Delaware website.
Myth: Delaware has won a race to the bottom by favoring manager interests over the interests of shareholders.
Fact: Many businesses choose to incorporate in Delaware because Delaware provides a well-developed body of corporate law (applied in an efficient manner by expert judges)27 that makes Delaware corporations more effective creators of value.28 Delaware does this by permitting managers and directors to make good-faith business decisions—including taking business risks in the corporation’s best interests29—as well as by policing and punishing disloyal conduct and conflicts of interest.30 This balanced corporate law stakes out a middle ground between states that have deliberately crafted their corporate law to be more protective of directors, officers, and controlling shareholders,31 and other states that have sought to tilt the balance more in favor of minority shareholders.32 Largely for these reasons, many scholars believe either that there is no race for corporate charters33 or that the race is or was to the top.34
On balance, there is arguably no other U.S. state that provides stockholders with more rights and flexibility than Delaware grants stockholders, nor whose courts have so consistently vindicated the rights of stockholders in litigation. By contrast, a majority of Delaware’s sister states compete with Delaware by being more protective of managers.35 These states have strong anti-takeover statutes and related laws that impede takeovers and limit the extent to which corporate managers must make the stockholder’s best interests their primary concern.36
Precisely because its law is balanced and flexible, and protects investors legitimate interests, Delaware is the U.S. domicile favored both by most investors in and most managers of American public companies.
Myth: Delaware tax loopholes help companies evade taxes owed to other states.
Fact: Under the American federal system, no single state has a monopoly on taxing the operations and profits of corporations and other business entities that operate in multiple jurisdictions. Rather, taxes as a general matter are apportioned among the many states in which a business operates, according to such factors as sales, property, and employees in each state. Because Delaware is a small state, the overall tax burden imposed by Delaware is a small consideration to any business that conducts a large amount of national and international commerce, especially in comparison to the taxes owed by such businesses to the U.S. federal government and the larger U.S. states in which such businesses operate.
Each of the 50 states makes different choices on how to raise revenue.37 Many U.S. states derive the majority of their revenue from sales and use taxes (similar to a VAT tax), personal income taxes, property taxes, and corporate income taxes. Delaware’s top sources of income are personal income taxes and annual franchise taxes paid by businesses incorporated in Delaware.38 Businesses with operations in Delaware are often subject to taxes on corporate income and gross receipts from operations and sales in Delaware itself. Delaware is generally regarded as having a reasonable overall tax climate for operating companies, although many U.S. states impose lower taxes (either specific taxes or overall taxes) on companies operating within their borders.
The tax laws of all 50 states include a variety of tax exemptions, credits, and deductions. Delaware law exempts from the corporate income tax certain Delaware holding companies, which are corporations that derive 100% of their income from passive economic activity, such as licensing of intangible assets.39 This is not a loophole but instead is an exemption that is part of the overall tax strategy for Delaware—helping Delaware to attract multi-state corporations to locate operations in Delaware.40 Other states have chosen to enact different exemptions or use a lower tax rate for businesses, if they tax corporate income at all. Moreover, this exemption may be of limited utility—of more than 1 million legal entities in Delaware, fewer than 1% of these are Delaware holding companies, and that number is declining.41
Furthermore, many states have taken steps to ensure that they receive the proportion of tax revenue from companies operating within their borders that they deem fair. More than 20 U.S. states use a tax system called combined reporting, which effectively eliminates the ability of corporations with multi-state operations to shift income from a high-tax state to a low- or no-tax state.42 States that do not have combined reporting have also used their regulatory add-back authority to disallow tax deductions for intercompany transactions that appear to exist principally for tax purposes.43
Myth: Delaware is America’s onshore tax haven.
Fact: Comparisons between Delaware and sovereign nations such as the Cayman Islands are inaccurate. Delaware companies are subject to the same U.S. tax laws as companies formed in other states.44 Some suggest that the United States is a tax haven because (1) non-U.S. income of overseas affiliates is normally only taxed when it is repatriated45 and (2) single member LLCs formed in any state are treated as disregarded entities, enabling non-U.S. members of LLCs to avoid U.S. taxation on non-U.S. income. Whether such arguments are accurate, these are functions of U.S. tax law and have nothing to do with state (including Delaware) corporate or tax law. The keys to policing international tax evasion are strong enforcement by the U.S. Treasury Department and other agencies of existing anti-money laundering laws governing U.S. financial institutions, and strengthening anti-money laundering enforcement in countries with weak financial regulatory systems. Delaware is one of many states that actively cooperate with federal and international regulatory agencies.46
Myth: Delaware provides business owners and managers with anonymity and secrecy.
Fact: In the United States, information regarding a business’ owners, partners, officers, and other responsible persons is collected through tax authorities such as the U.S. Internal Revenue Service (IRS) and, in the case of businesses with operations in Delaware, the Delaware Division of Revenue. This information is collected in a variety of ways, including through applications for tax identification numbers,47 annual submissions of tax returns,48 and financial account holding reports.49
As a general matter, U.S. states do not collect the names of beneficial owners—the natural persons who ultimately own, control, or derive benefits from a company—through the incorporation process. But Delaware and the majority of states do require disclosure of the names of the natural persons who serve as directors.50 Delaware also requires each Delaware corporation to disclose the names and addresses of its directors on its annual franchise tax report.51 All such filings with the Delaware Division of Corporations are public records.52
Delaware has also taken a number of important steps to increase transparency. In 2002, Delaware became the first state in the nation to ban by statute the sale of bearer shares, which are unregistered shares that only require the transfer of a physical document and therefore lack the regulatory oversight of common shares.53 In 2006, Delaware enacted the nation’s first Commercial Registered Agent statute, bringing company formation agents under a limited form of regulation empowering the state to police deceptive or fraudulent practices. Delaware also requires corporations and LLCs to provide a direct contact person to their registered agents—providing law enforcement with a way to access the name of a natural person representing every company.54 In 2012, Delaware’s Secretary of State adopted listing standards that cracked down on company formation agents that marketed shell and shelf companies or anonymity and secrecy. The Delaware courts also provide an avenue to combat the improper use of corporate entities, including shell entities.55
Most importantly, Delaware provides legal mechanisms that enable managers, investors, and law enforcement to inspect the books and records of Delaware business entities.56 Such inspection requests occur frequently. In short, Delaware is not a secrecy haven, any more than any other state or the United States itself. Indeed, Delaware has done more than most states to ensure proper transparency.
For information on the law firms and corporate service providers that authored these articles, please visit our acknowledgements page. The State of Delaware is grateful for their assistance.
Legal Disclaimer: The materials contained herein are intended to provide information in regard to the subject matter covered. The Delaware Department of State is not engaged in rendering legal, accounting, or other professional services. If legal advice or other professional assistance is required, the services of a qualified professional should be sought.