Expanding operations is a key element of many businesses’ plans. A survey of global businesses found that 97% of respondents plan to move into new international markets by the end of 2023. For many companies, venturing into new markets raises the question of whether or not to set up a subsidiary. Often multiple factors come into play when making this decision.
1. Greater access to talent.
A subsidiary can eliminate geographic barriers to recruiting the best talent. Without being restricted by location, recruiters can access applicants with specific skill sets and focus on ability. This wider pool can be a game-changer, particularly for startup companies and businesses in specialized industries. Remote work is also becoming an expectation for many job seekers, so a subsidiary can give companies an edge in the talent market. In some cases, resource costs for a subsidiary are lower due to lower tax rates, labor costs, and other expenses in different jurisdictions.
If hiring is the top consideration, it’s essential to consider all of the advantages and disadvantages of setting up a subsidiary. Sometimes, the best subsidiary strategy is to look at alternatives, such as using an Employer of Record (EOR).
2. Expansion into new markets.
Establishing a subsidiary provides the parent firm with opportunities to enter markets and industries that would otherwise be out of its reach. With new international markets come new consumers and sales possibilities that allow the parent company to develop its brand in potentially lucrative locations.
Companies that establish a subsidiary abroad are generally given more weight by local industries and governments than a branch of a company would be given. By setting up a local presence, companies can better understand the needs of customers in that market and tailor their products and services accordingly.
3. As a response to the purchase of an offshore company.
An offshore subsidiary may hold foreign assets, trade internationally, and form joint ventures and partnerships more readily than one based in its parent company’s country. In some situations, a business benefits from establishing a separate legal entity in another country by lowering withholding taxes, increasing asset protection, and enhancing privacy.
4. To manage liability.
If a corporation’s subsidiary is involved in a legal battle, the liability lies with that subsidiary, ensuring protection for the parent company from any major financial penalties that may result. The parent company and subsidiary relationship is often viewed as similar to the relationship between a parent and child, in that a parent isn’t typically held legally responsible for the actions of the child.
In some areas, a company may be legally required to set up a subsidiary in order to conduct operations in that area. This is often the case with banking and insurance companies.
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6. To protect intellectual property.
Centralizing a company’s intellectual property assets can enhance management of those assets, reduce licensing, and even attract new investment. This structure also protects the valuable IP portfolio from potential plaintiffs and creditors by keeping them separate. In the event that the affiliated operating business is sued, separation of intangible assets would protect such items from future judgments.
7. As a tax strategy.
The tax benefits of a subsidiary can protect the parent company from tax liability. For example, a company may choose to locate its manufacturing operations in a country with lower taxes, while keeping its headquarters and sales operations in a high-tax jurisdiction.
When a parent company consolidates its tax reporting, it may be able to offset income from high-tax countries with losses incurred in low-tax jurisdictions.
8. To manage risk.
A subsidiary also provides a way to spread out risk and enter new markets without putting the entire company’s future at stake. A subsidiary can be used as a “test bed” for new products or services before they are rolled out on a large scale. If a subsidiary’s performance fails to live up to expectations, any losses incurred are detached from the parent company.
Evaluating a company’s risk tolerance and creating a risk mitigation framework is an important step in the decision to create a subsidiary.
9. To attract investment.
By setting up entities in other jurisdictions, a company can send a signal to potential investors that it is serious about doing business in that country. This can lead to increased investment and capital inflows.
10. To manage permanent establishment.
Many firms are concerned about their tax exposure. When sales reach a level at which a country’s corporate tax system is jeopardized, it may be time to establish an entity. Permanent establishment is determined when a firm’s commercial activities reach a critical mass at which it becomes subject to taxation in one jurisdiction.
The decision to establish a subsidiary involves multiple considerations, and it’s recommended to involve the legal, HR, and finance teams in the evaluation process. The operational challenges presented in subsidiary setup require a thorough evaluation of the tools and systems used. Let us show you how Airbase’s spend management system supports subsidiaries.