What is a Foreign Subsidiary? All You need to know.
If you are wondering whether opening a foreign subsidiary is ultimately the right path for your business, you need to understand how it works, what it will cost you, and what alternative solutions could be a better fit for your company.
A foreign subsidiary is an overseas company operating under a larger corporation that is established elsewhere. Also known as local entities, foreign subsidiaries allow companies to expand and operate in multiple jurisdictions.
The benefits include access to new markets, higher likelihood to remain compliant with local laws, better access to local resources, and more protection for parent companies. It allows you to compliantly employ people in a particular jurisdiction, which can be much more risky and cumbersome otherwise.
However, the potential risks are high. Setting up a foreign subsidiary means investing a lot of time and resources into building it up. Not every company can afford this. Here we break down what a foreign subsidiary is. We explain how it operates, the difference between a foreign subsidiary and a permanent establishment, and the risks both can pose.
How Does A Foreign Subsidiary Operate?
Unlike a branch office, foreign subsidiaries are separate legal entities and responsible for their own assets and taxes. Most importantly, a foreign subsidiary must comply with the law of the country it is set up in.
A company’s designation as a foreign subsidiary depends on how much stock the parent company owns of a subsidiary company. Usually a parent company owns 50% of the foreign subsidiary, but sometimes it is also wholly owned (100%). If a parent company owns less than 50% of a company’s shares, then it is designated as an associate or affiliate company.
A foreign subsidiary can provide the parent company with particular advantages, including tax benefits and assets such as property or earnings. The parent company, along with other shareholders, elects the board of directors. It is through this mechanism that the parent company can maintain control over management and operations of a foreign subsidiary.
Is A Foreign Subsidiary The Same As A Permanent Establishment (PE)?
No. These are quite distinct. A PE is not a separate legal entity. The main difference is in how corporate and income tax is levied, i.e. whether the parent company and PE are taxed in both jurisdictions, or just the foreign subsidiary in the jurisdiction where it operates.
Deciding which option is better may also depend on Double Taxation Agreements (DTAs) and whether these hold a tie-breaker clause. With a DTA, a PE can mean you only pay corporate taxes in one jurisdiction. On the other hand, a foreign subsidiary will pay taxes separately for its operations in the jurisdiction where it is set up.
Setting up a foreign subsidiary has some distinct advantages, including more flexibility, the opportunity to explore local economies, being able to list public stock, and protecting parent companies from liabilities.
But PEs do offer their own benefits, like tax benefits through DTAs and lesser costs and simpler processes for opening (and closing).
If I Set Up A Foreign Subsidiary, Can I Still Be Exposed To PE Risk?
Yes. PE risk is when a company is found to have a PE in a country and is concluding profit-generating business activities there. A foreign subsidiary is legally its own entity. If it is found that the parent company is basically doing business for itself through the foreign subsidiary this will trigger a PE presence. This can make the parent company liable to paying corporate taxes (in addition to potential fines).
What Are The Other Risks Of Setting Up A Foreign Subsidiary?
Both PEs and foreign subsidiaries require a large investment of resources and a high level of risk. Not all companies, especially young and burgeoning ones, can afford this. It also distracts from other high ROI activities.
Moreover, navigating different cultural, political, legal, and bureaucratic systems in different countries can take up a lot of resources. This can significantly hamper the success of a foreign subsidiary. Sound knowledge of local systems and practices is necessary to build a successful foreign subsidiary. Not all companies will have access to this or the resources to build this expertise quickly.
How Omnipresent Can Help You Grow
The risks of opening a foreign subsidiary are many. Fortunately, a foreign subsidiary is not your only option for global expansion. Instead, you can avoid these risks by setting up shop with Omnipresent.
As a global Employer of Record (EOR), we employ staff across countries for you so you don’t need to set-up several foreign entities. We employ 100% compliantly and take over all your remote employment admin. PE risk isn’t eliminated but significantly reduced for you.
What’s more, we navigate local bureaucracies on your behalf. With our range of expertise, spanning 150+ countries, we can employ your remote staff quickly and correctly. You save on time, costs and reduce your liability. You can focus 100% on your high ROI activities AND employ the best talent.
Get in touch so we can help your company grow fast and compliantly.