Your company is growing and the business wants to expand its presence to another country. But before setting up shop, you must make an important decision: what type of legal presence do we want to have? Deciding between a representative office, a branch, or a subsidiary has significant consequences related to taxation, liability, compliance, and operating costs.
Each country is unique. For example, setting up in France requires a very different approach than in Brazil. You must take into account politics, culture, legal system, tax, etc. This article provides a summation of each consideration and the pros and cons for these types of presence.
A representative office (RO) is the simplest but most limited form of business establishment in a country. It is essentially a beachhead. ROs generally need to be registered with the local government and are typically limited from generating revenue. However, they usually can have employees in the country.
ROs can be used to evaluate a market before full commercial entry or to support business partners in the jurisdiction. The tax obligations of ROs are typically limited to employee withholding and payroll taxes.
Uses for ROs:
- market research and testing
- negotiating with local companies
- distributing products or services through local distributors
- promoting products or services without doing direct business activities and profit generation
On the other hand, a Branch Office (BO) is a direct extension of an existing legal entity in the company group into a new country. This is typically achieved via registering or qualifying a foreign entity in another country. BOs are designed to generate revenue and operate production facilities in a country.
However, a BO is not a distinct legal entity from the parent company and does not offer the benefits of parental asset liability protection. BOs often are subject to a 20% withholding tax.
A subsidiary entity is more complex than a RO or BO. It is a separate legal entity formed in the target country. The definition of a subsidiary is an entity that the parent owns 50% or more of. If ownership is less than 50%, then the entity is an affiliate of the parent where the parent is a minority shareholder.
The main reason for using a subsidiary rather than a BO is maintaining corporate separateness from the parent. This enables businesses to isolate risk exposure to the amount of capital investment the parent has made in the subsidiary. The legal concept is that each corporation has a unique identity, and parents should not be de facto held liable for subsidiary liabilities (similar to how the parents of natural persons are not usually held liable for the activities of their children). Read this article for more information on the role of subsidiary management in limiting parent liability.
However, another advantage of using a subsidiary is to access the tax laws of the country where it is domiciled. The target country may have tax laws that are advantageous to the planned business activities that may improve overall business profitability.
Comparing Branch Offices vs. Subsidiary Entities
Example of Branch Office vs. Subsidiary
Company X, Inc. is a fast-growing technology company based in the United States. It is seeing an increase in demand from Brazil and wants to establish a sales office there to acquire Brazilian customers faster. A decision is made to open an office in Sao Paulo. They decide to form a subsidiary Company X, SA (an SA is the Brazilian equivalent of a corporation).
Despite the Brazilian subsidiary being controlled by the US parent Company X, Inc., it is subject to Brazilian taxation and laws. The parent owes no taxes to Brazil, and the subsidiary owes no taxes to the United States. Company X, Inc. is also protected from liabilities that Company X, SA may incur from activities in Brazil.
If Company X had decided to open a Branch Office in Brazil, any income earned in Brazil would be subject to US taxes. Any liabilities incurred in Brazil would be attached to Company X.
Is Opening a Branch Easier Than Opening a Subsidiary?
Not necessarily. Like a legal entity, branches must also be registered with the local commercial register of the government. Some annual corporate formalities may not be needed, but other accounting and regulatory requirements must typically still be employed. Often branches are used for very limited scope or temporary activities.
Effective Management Branches and Subsidiaries
Staying in control of international Branches Offices and Subsidiary Entities is a substantial amount of work and complexity. In a recent survey by EY, 89% of legal department leaders reported significant challenges with legal entity management giving them concerns about being deal ready.
Download our ebook Best Practices in Corporate Subsidiary Management for more information on effective strategies and frameworks to stay in control of your entity structure.