Any company planning to expand its business to a new location often tends to ponder its new business entity’s structural and operational aspects. Affiliates, Branches, Mergers & Acquisitions, Representative Offices, Subsidiaries, or even Professional Employer Organizations (PEO) are various mechanisms for businesses to expand their operations and reach.
However, companies specifically look out for opening up a branch vs. a subsidiary to stay legally compliant when expanding into a new jurisdiction or business niche.
In this context, we present this post on the differences between branch and subsidiary and throw light on new-age global employment solutions.
Key takeaways:
- The parent company owns both branch and subsidiary companies, but they differ significantly in many aspects.
- A subsidiary helps enter a new market or business niche.
- A branch office enables companies to satisfy the customer’s need for face-to-face interaction without incorporating an entirely new entity.
- Global employment solutions like Multiplier can bypass setting up a business entity when entering new markets.
What is a Branch Office?
A branch office is another location for your business other than the main office to conduct operations. A branch office allows for business expansion while maintaining control.
The most popular method to serve local clients is through a hub and spoke structure. Just like the spokes of a wheel are attached to a single hub in the center, a single home office serves multiple branch offices by carrying out administrative functions.
A branch office is also a representative office with a dedicated branch manager reporting directly to the head office. It usually carries out the same operations performed by the main office. It may also maintain smaller administrative teams such as human resources, marketing, and accounting.
As parent organizations have 100% ownership, branch offices do not enjoy the status of separate legal entities. All liabilities associated with it extend to the parent company.
Example: The Reserve Bank of India. RBI, also known as India’s Central Bank, has its headquarters in Mumbai, Maharashtra. To increase the coverage and expand support, it now has 31 branches all over India, primarily located in capital cities.
What is a Subsidiary?
A subsidiary company is owned and controlled by another business. Usually, the owning business is otherwise referred to as a holding company or the parent company.
The parent company owns between 50% or more ownership stakes in the subsidiary. Usually, subsidiaries are considered separate legal entities. It may or may not conduct the same business as the parent company. Liabilities are limited to the subsidiary itself.
In terms of governance and compliance needs –
- The subsidiary is allowed to frame its processes differently from the parent company.
- The subsidiary can maintain its accounts separately
- The management structure in a subsidiary is subject to local regulations
Example: Television channels like HBO, CNN News Group, Warner Bros., or publications like Time Magazine and Entertainment Weekly are all subsidiaries of Time Warner.
Branch VS Company: Opening up a Branch Office or Forming a Subsidiary
Businesses looking to expand nationally or internationally need to choose carefully between setting up a branch vs. a legal entity. The merit (and demerits) of setting up a branch and subsidiary differ depending on the business.
The following section discusses the critical difference between branch offices and subsidiaries.
Ownership stakes
The most fundamental difference between a branch and a subsidiary is the percentage of ownership stake. A branch has 100% ownership stakes in its parent company. Whereas in a subsidiary, the ownership is greater than 50%. If a subsidiary is 100% owned, it is referred to as a wholly-owned subsidiary.
Business operations
Branch and subsidiaries may have some structural similarities. However, their corporate setup is different. A branch operation carries out the same function as the head office. It acts as an extension of the company operating in a different location. In contrast, subsidiaries are not bound to carry out the same operations as a parent or holding company. It may or may not carry the same functions as a holding or parent company.
Reporting hierarchy
In a branch company, parent organizations usually hand the responsibility and instructions to the branch manager. The activities are reported to the branch manager, who reports directly to the head office. However, a subsidiary company is accountable to the holding or parent company.
Reason to set up a branch or subsidiary
Branch office is established to extend business coverage, easy administration, and distribution of goods and services to the customers. It has a headquarters, and branches are set up at different locations doing the same operations. A subsidiary is set up with the sole aim of expanding business. The profits earned through a subsidiary are usually invested in other assets and companies.
Legal status
A subsidiary is a separate legal entity, unlike a branch company. It generally functions and operates independently, depending upon the ownership stakes. The parent company is liable if a branch company gets into legal matters with customers. However, this is not the case in subsidiary companies.
Utilizing systems and resources
As a branch company is not an independent entity, it can use the parent company’s resources and systems to function. It can use the same slogans, logos, and procedures to run the branch. A subsidiary can do the same, albeit it can set up operating resources and systems utilizing the independent entity status.
Liability
Due to its legal status, a subsidiary is liable on its own. It can not extend its liabilities to the holding or parent company. It has to maintain its separate finances and maintain its individual accounts. On the other hand, the branch’s liability is extended to the company it belongs to. Branch companies have an option to either maintain separate accounts or set up joint accounts.
Status after business loss
Businesses often face profits and losses. If a branch suffers from continuous losses, the parent company can decide to close the branch office. However, if a subsidiary faces a loss in business, the parent company can choose to sell it to another company.
Advantages & Disadvantages of Branch Office
Companies choose to set up a branch vs. a subsidiary to support many client-specific tasks. The administrative extension enables companies to conduct business closest to local clients and be better informed of the local market needs. By opening a branch company, parent organizations can satisfy customer needs without incorporating an entirely new entity.
It enables quick scaling of operations and in-market presence.
Opening up a branch vs. a subsidiary also ensures additional benefits to the parent company like
A greater level of control by the parent company
The parent company is allowed to control the day-to-day functioning of its branches overseas as it has 100% ownership of the branch company.
The branch office is cheaper to open
Opening up a branch office requires no share capital requirements and less compliance cost, and thus more affordable to open.
Branch offices are recognized globally
Subsidiaries may not be recognized in some countries, but a branch office is widely recognized as it is not a separate entity.
Predictable tax benefits
Considering branch vs. subsidiary taxation, the branch office offers a better choice due to the double tax treaties signed by almost all countries.
Opening a branch or legal entity like a subsidiary also has challenges and issues. The expansion for business purposes is often limited by corporate decisions or the target market’s legal and labor law requirements. Let’s list the most significant problems with opening a branch in any foreign country.
Limited business opportunities
- Exploring potential business opportunities with branch offices becomes even more challenging, severely restricting the parent company’s activities.
- It happens primarily due to the ownership structure as the parent company is 100% liable for any debts, fines, or legal settlements that a branch office is obligated to pay.
- Expanding into newer markets and exploring newer business niches by setting up a branch office also puts the parent company at risk.
Visa and immigration issues
- Unlike a subsidiary that is a local entity, a branch office is limited when it comes to sponsoring visas to bring in employees from overseas.
- On the other hand, hiring local talents becomes difficult as branch offices are not separate entities.
- It complicates transfers within the parent organization and the formation of global teams.
Commercial trust and reliability
- Businesses often prefer to deal with locally incorporated companies in their jurisdiction, mainly for trust and reliability.
- A branch office set up in a foreign country is not a separate entity and thus not responsible for any local debts.
- Dealing with a foreign company’s branch carries additional risks like international litigation in case of contractual disputes.
- It may discourage local businesses from dealing meaningfully with a foreign company’s branch office, thereby losing potential business opportunities for the parent company.
Advantages & Disadvantages of Subsidiary
Companies can form subsidiaries over branch offices if they have the time & resources to conduct a new market feasibility study.
Global companies often directly explore the market potential through a branch office. Upon positive results, companies incorporate a subsidiary in a foreign country. Since subsidiaries require 50% or more stake ownership, it becomes relatively cheaper for the parent organization to establish a subsidiary.
For instance, you can explore the benefits of opening a public or a private limited subsidiary company in the UK or forming an LLC in Dubai. Many US-based companies catering to the European market choose Ireland for easy compliance. Many also take advantage of free trade zones in the UAE to cater to the growing African market.
The subsidiary can be delinked effectively from the parent company. It allows the parent to venture into new business niches without any liability yet effectively control profits and revenue!
Forming a subsidiary vs. branch office also ensures additional benefits to the parent company like:
Establish market presence
Setting up a local legal entity increases the market perception of your brand.
Protection under local laws
Most business protection laws available for local businesses are also available for subsidiaries.
The flexibility of investment
The parent company can invest depending on risks associated with the new market location or the business niche. Local market borrowings can entirely reduce financial dependency.
Choosing a subsidiary for foreign expansion may seem a favorable choice between a branch and subsidiary. However, it has the inherent risk of being a separate legal entity. Forming a subsidiary in the desired jurisdiction can be complex and expensive.
The significant cons of forming a subsidiary are discussed below.
Lack of administrative control
- The parent company may have the ultimate control of the subsidiary through its voting rights and ownership stake but does not directly make decisions for the subsidiary.
- A subsidiary and its employees are not necessarily part of the parent company.
- The lack of control may result in substantial revenue outflow and eventually loss of reputation for the overall corporate group.
- As parent companies have ultimate control, much to and fro occurs in the day-to-day activities. Naturally, the operations and major decisions get hampered.
- It is best described in the recently concluded litigation by the US Department of Justice on the Goldman Sachs case. The company agreed to pay $2.9 billion in penalties under foreign corruption legislation for actions carried out by its Malaysian subsidiary.
Regulatory and cultural challenges in a foreign country
- A subsidiary operates solely in a foreign country and may face difficulties adjusting to cultural, political, and regulatory environments.
- Sudden legal or financial change in the foreign country where the subsidiary is based can cause disruption and financial challenges.
- It prompts the parent company to divest some percentage to local ownership in a subsidiary.
- It is best described in the context of how Starbucks Corporation runs its coffee business. In Japan, Starbucks Corporation has set up a subsidiary, whereas a 50:50 joint-venture is set up between Starbucks Corporation & Tata Consumer Products for the Indian market.
High establishment & exit cost
- Companies usually establish a subsidiary if owning real estate or heavy capital equipment is required to conduct business. It leads to complex legal issues around local ownership and how a subsidiary is taxed.
- In circumstances of lean profit or revenue, exiting from a subsidiary involves complex legal and financial questions, unlike a branch office.
- It is best described in the ongoing winding-up process of Ford Motors from India. Currently, the US-based motor company is facing complex and costly legal and financial negotiations in terms of labor compensation and factory sales deal.
Freedom From Setting up Various Business Entities for Expansion
A subsidiary seems to be more flexible than the branch, scoring big in the branch vs. subsidiary battle, primarily revolving around the following aspects-
- A subsidiary may issue or transfer shares to third parties such as partners, investors, or venture capitalists.
- It makes raising funds for local growth easier, thus securing the parent company.
- Unlike a branch, a subsidiary can be listed on the stock exchange.
But if you carefully notice the difference between branch office and subsidiary, one common issue emerges – the issue of hiring & employing local talent.
Fortunately, innovative solutions are available for businesses to expand their operations even without setting up a branch or subsidiary.
Say, a global Employer of Record (EOR) solution enables your company to compliantly employ talent on your behalf and manage all payroll, benefits, risk mitigation, and compliance. At the same time, you maintain day-to-day control of your supported employees.
The significant benefit of an EOR over a branch vs. company legal entity is that –
- You can establish a foreign presence quickly with proper compliance.
- You can wind up your business operations just as fast in the future.
- Your internal team saves valuable time and effort for your internal teams to navigate through local regulations and different tax requirements.
Multiplier is the Leading Choice for Global Business Expansion
Companies wanting to own real estate or a prominent legal presence often need to open a branch office or foreign subsidiary to remain compliant.
For everything else, global employment solutions like Multiplier can simplify your business expansion. Multiplier provides comprehensive SaaS-based solutions to take care of your global teams’ payroll, taxes, social contributions & local insurance policies in over 150+ countries. Our team of experts will help your company expand internationally by bypassing the setting up of an entirely new business entity when entering global markets.
We are trusted by industry leaders like Amazon, Control Risks, Stahl, and Graphisoft. You, too, can benefit from our seamless end-to-end global payroll and compliance solutions.
