A foreign subsidiary is a business entity wholly or partially owned by another entity from a foreign country. Another name for a subsidiary company is a daughter company. If the parent company owns less than 50% of the foreign entity, it’s called an affiliate company.
The company owning the foreign entity is called the holding company or parent company.
Even though a parent company can own 100% of the daughter company, they are not a single entity. The subsidiary is a separate legal entity from the holding company as far as all tax and liability matters are concerned.
Despite the subsidiary being a separate legal entity, the holding company can still control how the subsidiary operates proportional to the parent company’s ownership stake in the subsidiary. The holding company typically implements policies and makes decisions on behalf of the foreign company.
What’s the difference between a branch office and a subsidiary?
A branch office depends on the parent company, while a subsidiary is legally independent of the parent company.
A branch office is part of the parent company, set up in another country. The foreign branch depends on the parent company and executes all of the same business activities as the parent company. Think of it as a satellite office: it’s physically in another location but functionally (and legally) operated by the parent company. With a branch, you can use the same tax return as the parent company and benefit from tax agreements that stop you from paying duplicate taxes in both locations.
A subsidiary, on the other hand, is a legally independent entity. While control still lies with the parent company, the subsidiary has much more independence. It conducts its own business operations and governs itself. It must also consider all of the local laws and regulations of the host country, which can vary significantly from those in the home country. A foreign subsidiary also has greater tax obligations and must file separately for the subsidiary as its own entity.
What’s the difference between a permanent establishment and a subsidiary?
A subsidiary is a foreign entity governed broadly by the tax authority in its home country. In contrast, a permanent establishment is a foreign entity that relinquishes some tax authority to the host country.
A permanent establishment is an international tax concept. Many countries adopt the concept to regain some tax control over foreign entities that may intentionally or unintentionally commit tax avoidance in the host country.
A foreign entity can attain or be assigned permanent establishment status if it meets the following criteria:
It maintains a fixed place of business in the host country
The company is a dependent agent meaning the parent company habitually exercises the authority to conclude contracts on the foreign entity’s behalf in the host country
A foreign subsidiary may fall into the category of a permanent establishment if it begins to “act” as a dependent agent of the parent company.
When a foreign entity falls into the category of a permanent establishment, the host country claims the right to assess and apply local taxes on the company’s business activity. These local taxes could include income tax on profits, VAT, sales tax, employment tax, and other excise taxes. PE may also require the entity to register locally and trigger payroll and corporate tax compliance requirements.
To avoid being a dependent agent, there are two conditions:
The foreign entity must be both legally and economically independent of the enterprise
The foreign entity must be acting in the ordinary course of its business in carrying out activities on behalf of the enterprise
What are the advantages of establishing a foreign subsidiary?
There are many advantages to launching a subsidiary in a new country. Apart from reaching new and profitable business opportunities, there are various tax benefits and incentives for global expansion.
Access to new markets and global employment: A foreign subsidiary gives the parent company a chance to introduce its product or services to new, lucrative markets worldwide. It also enables the company to hire full-time employees abroad without using a middleman, such as an employer of record.
Diversification of workload: Subsidiaries help manage the ever-growing activities of an expanding company. The workload can be split into smaller groups and delegated to daughter companies. This allows domestic and foreign workers to focus on smaller tasks, thus making the entire workload more manageable.
More credibility in the new market: Companies that launch subsidiaries in a particular country are likely to be taken more seriously by local businesses and governments. Local companies are more likely to do business with a foreign subsidiary registered locally, with legal and fiscal assets in the country where it is doing business.
Limited liability for the holding company: A parent company has limited liability for the business operations of its foreign subsidiary. This means the parent company has a great deal of control while taking very few risks.
Foreign Direct Investment (FDI) opportunities: A company that invests in a foreign country brings valuable technical business knowledge and skills to attract foreign investment.
What are the disadvantages of establishing a foreign subsidiary?
While establishing subsidiaries in foreign countries can be incredibly beneficial, there are some challenges to consider. The disadvantages primarily relate to navigating the foreign subsidiary per the holding company’s plans.
Long and costly process: Properly setting up a foreign subsidiary takes much time. The preparation and planning alone can last for months or longer.
Additionally, the costs of acquiring and successfully running a business in an entirely new market will require meticulous research and a sizable investment.
While the payoff is typically worth it, not all companies can afford the initial investment of time and financial resources. This is especially true if you’re planning incorporation into several new markets or hiring from multiple foreign countries.
Cultural and scheduling differences: Being a part of an international business means that a company will have to adapt to different business cultures and approaches to task completion. Since business owners usually staff foreign subsidiaries with employees from the host country, management from the holding company might encounter conflicting schedules and holidays. With prior planning and execution, these conflicts can be easily remedied.
Increased bureaucracy: Making decisions on a company level can become demanding, as decisions have to go through various levels of the parent and daughter company.
Additionally, sometimes conflicting international tax laws and other regulations apply to the holding company and the subsidiary because they are in different countries.
These things mean that the shot-calling process will take significantly longer than it usually does and require more people to participate. Finally, both companies might need to hire a legal team to overcome the legislation differences in both countries.