Key Takeaways
1. A branch or branch office is a regional component of a broader company and can be contrasted with the main (or ‘head’) office.
2. A subsidiary is a company that is majority-owned by another company (the latter often known as a ‘parent’ company).
3. There are pros and cons to establishing a branch office, or a subsidiary, as part of an international expansion. Generally speaking, a branch office can be a cheaper and faster option. However, it comes with substantial compliance risks for the company as a whole.
4. Any business considering international expansion should consider all the possible options for getting established overseas. Beside branches and subsidiaries, this means considering affiliates, mergers and acquisitions, representative offices and global PEOs.
An important issue for any business expanding into a new location (whether nationally or internationally) is to work out the correct structure for its business operations in a new location. And the key question here is, should you open a branch or a subsidiary? Here we explain the difference between the two, and look at the pros and cons of each option.
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What is a Branch or Branch Office?
At a certain point, every growing business will need to expand outside of its main office. It is at this point that ‘branches’ of the company are usually created.
In many cases, the branch office will carry out exactly the same activities as the main office. It is headed by a ‘branch manager’ (or in some cases a ‘country manager‘) who reports directly to head office.
Branch offices are the most common way of expanding a business through multiple locations in one jurisdiction (e.g., the bank HSBC has nearly 600 branches throughout the UK serving individual population centres).
A branch has no distinct ‘legal personality’ from the head office. They are both components of the one broader company. This means that the branch manager is directly subordinate to head office, all transactions are carried out in the name of the broader company, and the company as a whole is liable for any actions of the branch.
A branch office can be distinguished from a ‘Representative Office’ or RO, which only carries out very limited activities on behalf of the company (i.e., not core business).
What is a Subsidiary?
A subsidiary is a company where the majority of voting shares or stock in that company are owned by another company (the latter company being called the ‘parent company’).
In a wholly-owned subsidiary, the parent company will own 100 percent of the voting shares in the subsidiary.
A subsidiary can be contrasted with an affiliate, where less than 50 percent of the company is owned by another company.
Setting up a foreign subsidiary is a common vehicle for international expansion (see, for example, the Chinese model of a foreign-invested enterprise or ‘FIE). They may be set up from scratch in a new location, or be created as the result of a merger or acquisition.
Read more about the process for setting up a foreign subsidiary at Setting Up a Foreign Subsidiary: The Main Advantages and Disadvantages.
Unlike a branch, a subsidiary has an entirely separate legal personality from the parent company. This means it can enter into contracts in its own name and that it has distinct tax liability from the parent company. It also means that the parent is not automatically liable for activities carried out by the subsidiary.
Below we look at the pros and cons of choosing a branch or a subsidiary.
What are the Pros and Cons of Setting Up a Branch Office?
The advantages of setting up a branch office include:
- Administrative simplicity
- A subsidiary is a regular company under the laws of the jurisdiction where that company is set up/and or operates. This means it needs to go through all the (often time-consuming) steps of setting up a company there.
- In addition, there is the sometimes cumbersome legal process of restructuring the parent company or broader corporate group to account for the new subsidiary.
- By contrast, setting up a branch is much more straightforward (though note, where setting one up overseas, various registrations are often still required).
- Cost
- The process set out above for establishing a subsidiary is often costly, as well as time-consuming. By contrast, it is usually a lot cheaper to set up a branch.
- Managerial control
- The branch is an integral part of the broader company. This means that company leadership have direct control over the actions of branch managers and their subordinates. As a separate entity, there is not the same control over a subsidiary and its staff.
- Simplicity of closure
- Where a branch office is not performing financially, or losing the company money, they can be closed down relatively simply. Employees can (usually) be made redundant or transferred, assets can be transferred and any outstanding debts will be managed by the broader company. Closure of a subsidiary is a far more complicated process (see discussion below).
The disadvantages of setting up a branch office include:
- Legal liability
- As the branch does not have a separate legal personality, its acts and omissions occur in the name of the broader company. This means the broader company (i.e., head office) is liable for the actions of its branch. For example, if employees at the branch act negligently, or breach contracts, the overseas company itself could be sued.
- Tax uncertainty
- Where a branch is located in a foreign jurisdiction, depending on the extent of its activities and its permanence, it could be considered a permanent establishment of the international business: This would make it liable for corporate income tax in that country.
- While subsidiaries always pay corporate income tax, the uncertainty for a branch office comes from the way in which that tax is calculated. The branch office will only be taxed on those profits which are ‘attributed‘ to that branch. This attribution task is a a somewhat subjective and uncertain process.
- Visa and immigration issues
- As a branch office is not a local company, it may be limited when it comes to sponsoring visas in order to bring in employees from overseas. This may make transfers within the broader organization, and the construction of a global team, more complicated.
- Relatedly, depending on the country, it may be more difficult for foreign companies with a local branch to hire local workers.
- Commercial trust and reliability
- Many businesses prefer to do business with companies which are also incorporated in their jurisdiction. Dealing with a branch of a foreign company presents additional risks. For example:
- Contractual disputes have to be dealt with internationally
- There is no local legal entity responsible for any debts. If the branch suddenly closes, any debt recovery against the foreign company will be expensive and complicated
- Inflexibility of corporate and tax structure
- Many international businesses uses complex transactions between subsidiaries in order to minimise their tax bill.
- Consider the following example from Facebook reported by Reuters in 2018: The Internal Revenue Service (IRS) was investigating the sale of intellectual property from Facebook Inc. to the Irish holding company (‘Facebook Ireland Holdings’). This company in turn leased the right to use Facebook IP to its subsidiary ‘Facebook Ireland Ltd’. As Facebook Ireland Ltd is Facebook’s main source of revenue outside the US (and Ireland has a low corporate tax rate), this saved the overall corporate group an enormous amount on its total tax bill.
- Whatever the merits of any individual tax structure, there is a flexibility available with subsidiaries that does not apply in the case of a branch office.
What Are the Advantages and Disavantages of a Subsidiary?
It is perhaps unsurprising that the advantages of setting up a subsidiary correlates closely with the disadvantages of setting up a branch. These advantages include:
- Managing legal liability
- The subsidiary itself, not the parent company, is the legal entity that enters into contracts in the jurisdiction and becomes liable for the operations of the business in that jurisdiction.
- Relatedly, a subsidiary can be liquidated and de-registered where it becomes insolvent. Generally, this means the assets of the parent company will be protected. By contrast, on branch closure, any remaining debts still remain as debts of the broader corporation.
- As well as managing liability under contract and tort law (e.g., negligence), a subsidiary helps manage the tax and compliance risks of operating in another jurisdiction. Generally speaking, it will be the subsidiary that is responsible for all employee income and payroll tax withholding. It will also be the subsidiary that is liable for any corporate income tax and value-added tax (where applicable).
- Commercial trust and credibility
- Many businesses (unerstandably) only wish to trade with locally incorporated entities. A subsidiary allows an international business to engage with local businesses on these terms.
- Tax Advantages
- As discussed above in the case of Facebook, subsidiaries can be used to reduce the overall tax obligations of a corporate group.
The disadvantages of a subsidiary include:
- Administrative complexity and cost
- As mentioned above, setting up a subsidiary can be complex and expensive, depending on the jurisdiction in question.
- Lack of control
- A subsidiary and its employees are not necessary part of the parent company. While the parent company has ultimate control of the subsidiary through its voting rights and ownership stake, it does not directly make decisions for the subsidiary.
- This lack of control can have substantial flow-on, and ultimately reputational effects, for the overall corporate group. For example, in ongoing litigation in the United States, Goldman Sachs has agreed to pay $2.9 billion in penalties under foreign corruption legislation for actions carried out by its Malaysian subsidiary.
- Ongoing compliance
- A subsidiary is subject to all the corporate compliance obligations of a local company. This includes financial capital requirements and ongoing financial reporting. In general, a branch does not have those obligations.
- Closure complexity
- A subsidiary cannot be easily closed down where it is not performing as expected. Usually, a drawn-out winding-up process is required. By contrast it is very straightforward to close down a branch office.
What Is the Best Option Overall?
There is no one expansion solution that is right in every case. For a more permanent presence, the compliance, certainty, and credibility of a subsidiary can make sense. Where the expansion is more tentative or temporary, opening a branch office may be adequate.
It is also worth considering other options that might be available besides a branch office or a subsidiary. Consider for example:
- Affiliates
- An international enterprise could invest in an affiliate (a company where it has a minority shareholding) overseas, rather than a subsidiary or a branch.
- This reduces the risk exposure of investment in another country. On the other hand, as it involves only a minority holding, it provides no control over the local entity and a limited ability to conduct business through it.
- A Representative Office
- A representative office (‘RO’) gives an organization a formal presence overseas. Notably, they are only allowed to perform limited activities on behalf of the international company they represent.
- Merger or acquisition
- Instead of setting up a new subsidiary or branch, an international enterprise might consider merging with or acquiring a local business.
- This can be an excellent way of ensuring that an international expansion is locally compliant and in line with the market in a new location.
- Professional Employer Organization (PEO)
- A PEO is a third party organization that hires employees on behalf of client companies. The PEO takes care of payroll, tax withholding and compliance tasks, while the employee continues to work at the day-to-day direction of the client company. By engaging a PEO you can have your international team based overseas, without needing to open up a branch or subsidiary.
- It must be noted, however, that a global PEO does not automatically eliminate permanent establishment risk, and businesses need to carefully consider whether they need a local entity (such as a subsidiary) in place.
- For more information, read What Does PEO Stand For?
Branch versus Subsidiary in Global Expansion
The relative merits of setting up a branch versus a subsidiary company, differ substantially depending on the business in question, and the country of expansion. This means it is essential to engage an international expansion partner to explain which option might be best for your company.
Horizons provides subsidiary incorporation, global PEO and international strategy advice for all types of global expansion. Contact our specialists to find out which option is right for your business.
