As the global economy expands, companies are eagerly setting up subsidiaries worldwide. Subsidiaries usually function as independent entities, thus, giving parent companies enough flexibility regarding taxation and liability. Parent companies may form a subsidiary to reduce new business and financial risks, fulfill the legal requirements in foreign jurisdictions, or separate their smaller entities into distinct brand identities.
Managing overseas subsidiaries is unique owing to differences in language, culture, legal environment, and tax laws. A basic understanding of why & how to create a subsidiary here can build pieces of information into a bigger perspective.
The formation of a subsidiary company will help isolate newfound creditors to only the exposed bad assets within the larger company. The incorporation of a subsidiary company is most helpful when operating overseas for legal and taxation purposes and to assess management opportunities. Global EOR solutions like Multiplier can be a digital alternative to setting up a subsidiary for businesses entering international markets.
Why do Companies set up Subsidiaries?
A company might decide to open a subsidiary company for the following general reasons:
Conducting business overseas requires the local incorporation of a company. The laws on creating a subsidiary vary according to the country and state. Parent companies can seek guidance from outside counsel or locally registered agencies to know the legal requirements.
Special filings are required to conduct businesses in a city or county in addition to the regulations imposed at the state or federal level. These filings, known as business licenses, vary significantly by industry and location.
Tax planning considerations
Similar to legal requirements, tax law also varies depending upon the country. Tax laws that apply now may or may not be valid the following year. Considering a local tax consultant is always advised.
Businesses make a subsidiary company take advantage of various benefits, including filing a consolidated tax return (along with its parent company) or even writing off selective losses the subsidiary might incur from the total income.
Global enterprises can manage and sell their subsidiaries overseas by opening a sub-company without affecting the parent company. They become responsible for subsidiary debt collection on the subsidiary’s account. It can provide detailed insights into business to operate in a more targeted manner.
- To raise money: A parent company can raise capital for its subsidiaries without incurring the risk of altering the company’s stock value.
- Transferability of assets: A company may form a subsidiary to control and facilitate the transferability of assets while leaving title to these assets undisturbed.
- Lifespan: A parent company entering a business or joint venture having a limited existence may open a subsidiary company or a separate entity. It allows for a more straightforward dissolution when operations have ceased.
- Performance: When companies are new to the market, it becomes essential to track their performance. Regular audits and financial statements help business owners quantify the organization’s success.
- To streamline brand approach: Subsidiaries can optimize vendor relations, marketing, and customer brand recognition by differentiating brand identities and company culture into a separate structure.
There may also be “trigger” events leading to the formation of a subsidiary company, such as:
- Adding new products or services to a company’s line
- Engaging in new market segments or a high-risk business
- Bidding on a contract in a new jurisdiction
- Taking advantage of local labor market skills, or state incentives
- Gaining ownership of property in another state or country
- Engaging in a joint venture
- Acquiring a company’s equity or practically all of its assets
Example: Why Google registered itself as a subsidiary under Alphabet Inc.
To separate its business lines from the stable search engine revenue model, Google is venturing into high-risk businesses with no zero guarantees of returns, say, remember Google Glass?
The goal is for Alphabet Inc. to keep trying out newer business ideas by compartmentalizing risks by creating sister companies (two or more subsidiaries under the same parent company) or a subsidiary limited liability company (LLC).
Today, Google is the most recognized LLC in the world. The flexibility of LLCs and the proliferation of incorporating subsidiary companies allow new possibilities in asset protection.
How to Make a Subsidiary Company?
To set up a subsidiary in another country, organizations need to follow certain steps, which are as listed below:
Evaluating business need to form a subsidiary
Check for FDI limits & business visas
In many countries, most sectors are open for foreign direct investment (FDI) without any prior approval for the incorporation of a subsidiary company. Additionally, it is essential to evaluate the scope of business visa requirements for shareholders/directions of subsidiaries in the proposed jurisdiction.
Form a working group
General practice is to form a working group after the board meeting decides on starting a sister company. A working group could ensure everyone is aligned on the risk mitigation framework.
The risk mitigation framework identifies various market risks and assesses costs of subsidiaries, tax justification, and communication gaps in the foreign jurisdiction.
A broad working group of management, HR, legal, finance, and accounting teams will help make an informed choice. Decide whether or not to outsource accounting for the entity and how to deal with audits or use professional translation services to align with parent companies’ goals.
Planning a subsidiary
Choosing the type of legal entity
When a company decides to register a subsidiary company, representatives of the legal and tax departments can choose among standard types of entities:
- Limited Liability Companies (LLCs)
- General Partnerships
- Limited Partnerships (LPs)
- Limited Liability Partnerships (LLPs)
- Representative Offices
- Branch Offices
LLCs are usually the best structure for small businesses as it promises personal liability protection, flexible tax options, management flexibility, less paperwork, and inexpensive to form a subsidiary.
Ultimately, the management’s choice will depend on the purpose of the subsidiary, the composition of its interest holders, local jurisdictional requirements, and tax implications. Management can consult accounting or attorneys to help decide on a suitable legal entity.
Choosing a subsidiary name
While deciding on names, organizations need to consider certain legal aspects. Some local statutes may require that a subsidiary name indicate the form of entity, for example, Alphabet Inc. or Google LLC.
Another consideration when choosing a name for a subsidiary depends on the branding strategy. The subsidiary’s name must include company’s name. The same applies to a joint venture.
Management must verify that no other business is registered under the same name. A name search is conducted in the state of domicile and in every foreign state where the subsidiary is expected to be qualified to do business.
To protect the name, the company should consult a trademark lawyer. Usually, companies can reserve the desired names for a set timeframe in anticipation of finishing setting up a subsidiary.
Foreign jurisdiction may often require extensive formalities such as office leases and opening a bank account. Make sure to remain mindful of the deadline of the name reservation in this context.
Electing directors and officers
After completing the steps mentioned above, the parent company can start recruiting directors and officers for the newly set up subsidiary. Organizations can recruit the parent company’s director or hire separate Directors and Officers for the subsidiary.
One important aspect of hiring a new subsidiary director and the officer is organizing proper training that describes the roles and responsibilities of the post. You can either conduct face-to-face training or online sessions outlining the duties of the position.
Documentation to set up a subsidiary company
To set up a subsidiary in a country, the parent company may require documents depending upon the country’s legal requirements. Here is a list of some standard documentation necessary to set up a subsidiary:
- Employer Identification Number (EIN)
- Bank Accounts
- Financial Statements
- A Business Plan
Other Aspects of Creating Subsidiary
Check the FDI limit of your sector
Most investor-friendly countries have an open policy for foreign direct investment (FDI). However, there may be a few sectors where it is restricted or not permitted. It is determined only on a country basis.
Draft government forms and documents
Identity documents of shareholders/directors of the parent company and proof of registered office in a foreign jurisdiction are the essential documents for registering a subsidiary company.
Further, declarations under applicable state & national laws must be met case-to-case basis.
All documents signed in a foreign country must be apostilled through the respective Embassy or per Hague Convention, as applicable.
Partner With Multiplier to Avoid Creating a Subsidiary
Managing global teams can be exhausting. Typically, organizations need to set up subsidiaries to start their business overseas. Multiplier can help enterprises bypass the process of forming a subsidiary when entering global markets.
Multiplier is a SaaS-based global Employer Of Record (EOR) solution for new-age companies. It facilitates seamless global employment and expansion for brands to set up remote teams across 150+ countries.
It is only possible through the presence of our local entities in each country. Our in-house experts and on-ground staff stay updated with labor laws and regulations to ensure you are 100% compliant in rapidly changing socio-economic environments.