In today’s business environment, there’s a strong encouragement for companies to establish offices in other countries, often in the form of branches or subsidiaries. With the ongoing globalization, more and more companies are seeking ways to expand their overseas operations, and setting up foreign subsidiaries is an effective approach. It greatly aids in helping companies enter new markets and gain tax benefits.
What are foreign subsidiaries?
A foreign subsidiary is a business entity held by another foreign company, known as a holding or parent company. Even if the parent company owns 100% of the subsidiary’s shares, they cannot merge into one entity. From a tax and liability standpoint, the subsidiary is a separate legal entity, independent of the parent company, though the parent company influences the subsidiary’s decisions and execution plans based on its ownership percentage.
Example:
One of the most famous cases of a subsidiary is Instagram, acquired by Facebook in 2012, with Facebook holding 100% of its shares. Post-acquisition, both companies operated under separate entities. Similarly, WhatsApp was acquired by Facebook in this manner. Additionally, Google and Google Nest are subsidiaries of Alphabet.
In daily life, many products, especially in the food industry, are produced by subsidiaries of well-known multinational corporations. For instance, KFC, Pizza Hut, and Taco Bell are subsidiaries of Yum! Brands.
Difference between branch and subsidiary?
A branch is part of the parent company, established in other regions worldwide, operating under the umbrella of the parent company and engaging in similar business activities.
A subsidiary is a legally independent entity. While under the control of the parent company, it has certain autonomy to conduct independent business operations and governance, regulated by the laws of its host country (which may differ significantly from those of the parent country). Foreign subsidiaries are considered assets of the parent company and must appear in the parent company’s annual reports. However, converting foreign subsidiary assets from foreign currency to domestic currency can be challenging.
What are the advantages of setting up a foreign subsidiary?
Establishing a subsidiary in a new country offers numerous advantages. Alongside new business opportunities, there are various tax incentives and global expansion prospects.
Market Entry: A foreign subsidiary provides the parent company with an opportunity to introduce its products or services in a lucrative global market.
Autonomy: The parent company can choose the board and executives, facilitating the integration of the subsidiary into its corporate culture and values.
Decision Control: With control over the foreign subsidiary, the parent company can exert greater influence on business plans and activities, executing strategic visions more effectively.
Diversification: Subsidiaries manage growth activities efficiently, dividing tasks into smaller groups to ensure focused efforts and a more controllable work plan.
Enhanced Credibility: Companies with foreign subsidiaries prioritize local business development, fostering trust with local governments and industries by having legal entities and assets in the region.
Limited Liability: The parent company maintains significant control with minimal risk, as its liability for the foreign subsidiary is limited.
Resale Value: If the subsidiary fails to meet standards, the parent company can sell it and recover investments.
International Direct Investment: Foreign investments not only bring funds into the host country but also provide valuable technology, business knowledge, and skills, benefiting the host country significantly.
What are the disadvantages of setting up a foreign subsidiary?
Establishing a foreign subsidiary offers immense benefits for the parent company, but it also comes with drawbacks, mostly related to the guidelines set by the parent company for the subsidiary.
Time-consuming and costly: Setting up a foreign subsidiary requires significant time and investment in preparation and planning, lasting for several months or longer. Acquiring and operating a business in a new market entails meticulous research and substantial investment. While the returns justify these investments, not all companies can afford the time and money required for the initial investment.
Cultural differences: International business requires adapting to various business cultures and approaches to task completion. Employees of foreign subsidiaries often come from the host country, leading to schedule and holiday conflicts for the parent company’s management. However, if the foreign subsidiary is established correctly, these issues are minor challenges.
Dealing with bureaucracy: Decision-making at the corporate level is complex, involving multiple levels of the parent and subsidiary companies, sometimes conflicting with the laws of the host country. This means decision-making processes will be lengthy and involve more people, and both companies may need to hire legal teams to overcome legislative differences between the two countries.
Difficulty in finding suitable candidates: Talent recruitment can be remedied through outsourcing to headhunters, and any position in the subsidiary can be filled with the best candidates selected by experts with rich legal and cultural knowledge.
Reach a verdict
After listing all the pros and cons, it seems that establishing a subsidiary yields more benefits than costs. However, if the new company is not acquired or established correctly, all the advantages can easily turn into issues. For example, the parent company may struggle to handle the organizational and financial pressures of establishing a foreign subsidiary.
There are methods to profit from establishing a foreign subsidiary and mitigate the potential risks of acquiring a subsidiary. For instance, setting up a representative office in the new market or operating through the PayInOne system when hiring foreign employees. We can assist companies in hiring anyone worldwide, anytime, and ensure full compliance with local laws and regulations.
