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What Is a Foreign Subsidiary & Is It Right for a Business?

In order to understand what a foreign subsidiary is and is it right for a business, read on to learn more!

What Is a Foreign Subsidiary?

A foreign subsidiary is an entity established by a parent company outside its country of origin. It may be incorporated in another country or have operations in several countries.

A subsidiary company is also known as a daughter company. A holding company, also known as a parent company, is the company that owns the foreign entity.

Even if a parent company owns 100% of a daughter company, the two are not the same. The subsidiary is a distinct legal entity from the holding company in terms of taxation and liability.

But nevertheless, the holding company has an impact on how the subsidiary conducts business: policies, decisions, and plans are implemented in proportion to the parent company’s ownership stake in the subsidiary. Furthermore, if this ownership is less than 50 per cent, the foreign entity is referred to as an affiliate company.

The Financial Relationship Between a Holding Company and Its Subsidiary

A foreign subsidiary is a parent company asset that will appear on the parent company’s annual balance sheet. Even so, it can be challenging to convert assets from a foreign currency into the home country’s currency.

Furthermore, because it is located in a different country, a daughter company will typically use different bank accounts than its parent company. Foreign subsidiaries are usually exempt from US income tax because the IRS does not consider them to be US companies, even if a US company wholly owns them. A foreign subsidiary is taxed in accordance with the laws of the host country or the country in which it resides.

As long as the host country’s laws and regulations allow for the formation of subsidiary companies, the parent company does not need to open a branch office. This new daughter company will suffice.

What Are Some Examples of Subsidiary Companies?

Instagram is one of the most well-known examples of a subsidiary company. While they operate as separate entities, Instagram is a wholly-owned subsidiary of Meta, which Facebook acquired in 2012 (and became Meta in 2021). The same can be said for the messaging app Whatsapp. Similarly, Alphabet Inc.’s Google LLC and Google Nest are subsidiaries.

Subsidiaries make the majority of products (especially in the food industry) of a few large, multinational corporations. Yum! Brands’ subsidiaries include KFC, Pizza Hut, and Taco Bell.

Branch Office Vs Subsidiary

A branch office is a division of the parent company that is located in a different part of the world. The foreign branch is reliant on the parent company and performs all of the parent company’s business functions. Consider it a satellite office: it’s physically located somewhere else, but it’s functionally (and legally) run by the parent company.

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On the other hand, a subsidiary is a separate legal entity from the parent company. While the parent company retains control, the subsidiary has far more autonomy as it runs its own business, governs itself, and adheres to all of its laws and regulations, which can differ significantly from those in the home country.

Permanent Establishment Vs Subsidiary

By default, your subsidiary’s existence does not count as a permanent establishment (PE). However, to make sure you’re not taking any chances, make sure your subsidiary meets the following requirements:

  • It’s a fixed location for doing business
  • It brings in revenue for the parent company
  • The activities of the subsidiary are under the control of the parent company.

Pros of Establishing a Foreign Subsidiary

There are numerous benefits to establishing a subsidiary in a foreign country. There are various tax benefits as well as opportunities for global expansion, in addition to discovering new and interesting business opportunities.

  • Access to new markets and global hiring
  • Alignment of company culture
  • Diversification of workload
  • More credibility in the new market
  • Limited liability for the holding company
  • Resale potential if things don’t go according to plan
  • Foreign Direct Investment (FDI) opportunities.

Cons of Establishing a Foreign Subsidiary

While acquiring subsidiaries in other countries can be extremely beneficial to parent companies, there are some drawbacks as well. These drawbacks are mostly related to establishing a foreign subsidiary and navigating it in accordance with the holding company’s plans.

  • Length and costs of the process
  • Cultural and scheduling differences
  • Increased bureaucracy
  • Difficulty in finding the right staff.

A Foreign Subsidiary Is Right for a Business?

Remember opening a foreign subsidiary isn’t for everyone. Whatever your reasons for establishing a local subsidiary, remember to weigh the risks and investigate the costs and paperwork involved. If a subsidiary isn’t the best option, you can open a branch office, work with a third-party Employer of Record (EOR) or Professional Employer Organization (PEO).

Get in touch with the specialists at Vakilsearch to ensure you do it right.

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