Branch vs Subsidiary – Which Is Best for European Expansion?

A business development team discussing whether to open a new branch or subsidiary. They have a tablet and documents in front of them.

When it comes to expanding your business in Europe, choosing between establishing a branch office vs a subsidiary is a decision that can shape your company’s future. But what’s the real difference between the two, and which is best for your international strategy?

A subsidiary vs branch comparison reveals that a subsidiary is its own legal entity, whereas a branch operates as an extension of your parent company. This fundamental distinction impacts liabilities, control, and fiscal responsibilities, all of which are crucial for your expansion success.

Our article dives into the nuances of both options, equipping you with the necessary insights to choose the right path for your European venture.

Key Takeaways

  • A branch is an extension of the parent company, not a separate legal entity. This means the parent is fully liable for the branch’s liabilities, but it also allows for financial integration and simpler tax filing.
  • A subsidiary is a separate legal entity usually controlled but not fully owned by the parent company. It offers legal and liability protection, autonomy, and better local market adaptation at the cost of complexity and investment.
  • Choosing between establishing a branch or a subsidiary for international expansion depends on factors like desired control, tax advantages, and market presence.
  • Alternative options like EOR services offer flexible market entry without creating a local legal entity.

Branch vs Subsidiary - What's the difference?

Simply put, a branch office is a part of the parent company conducting the same business under the same name, whereas a subsidiary is its own legal entity, owned by the parent company, and can adapt its operations to the local market.

Their legal statuses set them apart.

A branch is seen as part of the parent company, not a separate entity. This means the parent company has direct control over the branch and is fully liable for any issues it faces.

A subsidiary is a distinct legal entity that is separate from its parent company. This means that it has its own legal rights and obligations. This provides a layer of legal and liability protection for the parent company, as the subsidiary is responsible for its own business operations.

Ownership-wise, the holding or parent company fully owns a branch, while the ownership of a subsidiary can fluctuate. The parent company typically owns between 50% or more ownership stakes in the subsidiary, effectively giving it control over the subsidiary while also allowing the possibility of local or third-party ownership.

What is the Branch Office Model?

Branch offices function like smaller versions of their parent companies, often replicating their operations. They are usually led by a branch manager who is tasked with the day-to-day oversight of operations and reports directly to the parent company’s head office.

Financial Integration with Parent Company

Financial integration with the parent company is a major advantage of a branch office. Branches operate as an extension of the parent company and typically do not need to file a separate tax return, simplifying tax reporting procedures. However, this integration also means that the parent company is fully liable for any issues faced by the branch.

On the other hand, establishing a foreign business branch in a foreign jurisdiction may lead to corporate income tax responsibilities specific to that region, which introduces additional tax complexities for the parent company.

Strategic Advantages of a Branch Office

Branch offices offer several strategic advantages, especially for companies looking to penetrate new markets quickly. Since branches function similarly to the parent company, they can help maintain consistent business operations across borders, offering a seamless customer experience regardless of location.

Example in action:

A company that provides specialised financial services might opt for a branch office to ensure that its proprietary methods and customer service standards are uniformly applied, which is crucial for maintaining the brand’s reputation for excellence. Additionally, setting up branch offices can help maintain brand consistency across markets, thereby boosting credibility and reputation.

Branches may benefit from existing trade agreements or tax treaties that the parent company enjoys, which could result in more favourable tax conditions. In terms of market presence, a branch office can often be established more quickly than a subsidiary, allowing for a faster response to market opportunities and customer needs. This speed can be a decisive factor in industries where being first to market is a competitive advantage.

For companies that prioritise a greater level of control and oversight, a branch office allows for direct management from the parent company, ensuring that the strategic direction and operational decisions align closely with the company’s overall objectives.

Operational Challenges for Branch Offices

Despite their strategic advantages, branch offices also face several operational challenges. For instance, branches often encounter hurdles in sponsoring visas for employee transfers and hiring local workers due to the limitations imposed on foreign businesses.

Example in action:

A tech firm looking to establish a branch office in Spain may find that the Spanish immigration system has stringent requirements for work visas, making it difficult to transfer key personnel from the headquarters. Additionally, since the branch is not considered a separate legal entity, it may struggle with the perception of being an “outsider”, which can deter local talent from joining the team and hinder the development of a strong local workforce.

Forming a cohesive global team and attracting local talent is challenging for branches, as they are seen as extensions of a non-local parent company. This lack of separate legal status can also result in trust issues within the local market, as customers and business partners may prefer to deal with an entity that has a more established local presence.

Office workers sat at desks in rows working on computers. This is a foreign branch office.

What is the Subsidiary Model?

A subsidiary company is a separate legal entity that is wholly or partially owned by another company, known as the parent company. This structure allows for more flexibility and control over its operations.

Subsidiaries, governed possibly by a board of directors, must follow the laws of their operating countries. This allows subsidiaries to tailor their business practices to the local market and pursue financial independence and partnerships.

While subsidiaries operate with their own CEOs and management teams, the parent company may still have a significant influence over management decisions. However, thanks to the subsidiary’s status as a separate legal entity, the parent company is protected from direct liabilities arising from the subsidiary’s actions, such as product liability suits or financial losses due to strategic missteps.

Investment and Ownership Dynamics

Ownership dynamics in a subsidiary can be quite complex. A subsidiary is often majority-owned by a holding company, creating a corporate group where shareholder approval is typically not necessary to sell a subsidiary or turn a company into a subsidiary.

However, purchasing or setting up a subsidiary often necessitates substantial investment, potentially posing financial risks for the parent company, especially if it must guarantee the subsidiary’s loans. On the other hand, the financial liabilities of a subsidiary do not directly become the responsibilities of the holding company, which can limit the overall business risk.

Foreign subsidiaries can contribute to tax efficiency through strategic tax planning between entities. By leveraging differences in tax jurisdictions, a subsidiary can optimise its tax obligations through methods such as profit shifting, transfer pricing, and tapping into tax incentives offered by local governments.

This can result in a lower overall tax burden for the corporate group, which can be particularly advantageous for multinational companies operating in various countries with differing tax rates and regulations.

Autonomy in Local Markets

A key advantage of a subsidiary is autonomy in local markets. This autonomy empowers subsidiaries to tailor their operations to conform to local business environments, consumer preferences, and regulations, which can significantly enhance their competitiveness in the local market.

For example, a subsidiary can develop and offer products that cater specifically to the cultural tastes and needs of the local population, which may differ greatly from the preferences of the market where the parent company is based.

This localised approach not only strengthens the subsidiary’s appeal to the local customer base but also allows for more agile responses to market changes and competitive pressures. 

Ultimately, this strategic flexibility can lead to increased market share and profitability, thereby benefiting the subsidiary and contributing positively to the parent company’s global success.

Moreover, establishing a subsidiary as a local legal entity can:

  • Enhance the market perception of the brand
  • Increase its credibility within the host country
  • Contribute to a strategic competitive advantage by exploiting cost efficiencies in local markets

Complexities in Establishing and Managing a Subsidiary

Despite their numerous advantages, subsidiaries also bring a set of complexities. 

For starters, forming a subsidiary generally involves higher costs and requires more extensive regulatory and cultural adaptation.

Not having full ownership by the parent company over a subsidiary can often lead to:

  • A loss of revenue due to the subsidiary’s ability to make autonomous decisions that may prioritise local profitability over the financial interests of the parent company. This can result in revenue streams that are not fully aligned with the parent’s expectations or strategic goals.

  • Limited control over decision-making because the subsidiary operates as a separate entity with its own board and management. While the parent company may have significant influence, it does not have the final say in all business decisions, which can sometimes lead to strategic divergence.

  • Potential conflicts of interest can occur, especially when the subsidiary’s local objectives clash with the parent company’s global strategy. This can occur when the subsidiary pursues partnerships or initiatives that serve its own interests but may be at odds with the parent’s broader corporate vision or ethical standards.

  • Difficulties in aligning strategies and goals due to the subsidiary’s focus on its success within the local market. This can lead to a subsidiary developing policies, practices, or a company culture that is distinct from the parent company, making it challenging to maintain a cohesive global brand identity and operational uniformity.

While a subsidiary can serve as a legal shield for the parent during international litigation disputes, it also comes with administrative disadvantages that can complicate operations.

Comparative Analysis: Foreign Branch vs Subsidiary

A comparison of branches and subsidiaries reveals unique pros and cons for each. 

Branches are not separate legal entities and are seen as extensions of the parent company, which gives the parent company direct control over the branch. However, this also means that all liabilities of the branch directly impact the parent company.

Meanwhile, subsidiaries are separate legal entities that provide a layer of legal and liability protection for the parent company. However, due to its nature as a separate legal entity, forming a subsidiary entails a more complex and expensive process.

In terms of exit strategies, branches offer a simpler way to cease operations if needed, while closing or selling a subsidiary involves a more complex process. This difference can impact the parent company’s market flexibility when adapting to changes.

Legal and Fiscal Distinctions

The primary distinction between branches and subsidiaries is in their legal and fiscal characteristics. A subsidiary, being a separate legal entity, can enter into contracts and be liable for its own business operations. This provides limited liability protection for the parent company and shields it from direct responsibilities for the subsidiary’s debts.

On the contrary, a branch does not have its own legal standing, resulting in all liabilities affecting the parent company directly. This means that the parent company is responsible for any debts or obligations of the branch. While this setup offers some tax benefits, such as the ability to file a single set of consolidated accounts for a corporate group, it also introduces additional tax complexities for the parent company.

Foreign Branch vs Subsidiary Tax

Tax considerations differ for foreign branches and subsidiaries. 

Branches are typically taxed on income in the host country, but profits are consolidated with the parent company, potentially leading to double taxation without tax treaties. 

Subsidiaries are taxed independently as separate entities, allowing tax planning opportunities like transfer pricing to optimise obligations. 

However, subsidiaries face local tax compliance duties like filing separate returns

The optimal structure depends on the specific countries involved and the company’s global tax strategy. Professional tax advice is recommended when evaluating branch vs subsidiary taxation for international expansion.

Decision-Making Power and Control

In terms of decision-making and control, parent companies directly manage branch offices but have limited control over subsidiaries due to their separate legal identities. This difference can be a crucial factor for companies that value maintaining tight control over all aspects of their operations.

Exit Strategies and Market Flexibility

Branches and subsidiaries differ in their exit strategies. Branch offices can be dissolved more easily because they are not separate legal entities, which simplifies the termination process. Dissolving a branch often entails a less cumbersome unwinding of operations, as they are essentially treated as an arm of the parent company. Therefore, the parent company can typically close a branch with fewer legal formalities and reduced administrative burden.

On the other hand, closing a subsidiary generally involves a complex process, including liquidation or restructuring.

However, a potential exit strategy for the parent company is to sell a subsidiary to another company.

Choosing Between a Branch and a Subsidiary for Global Expansion

Choosing between a branch and a subsidiary hinges on your business’s specific requirements and objectives. 

Factors to consider include:

  • Your primary interests and goals for the new entity
  • Potential tax advantages
  • The level of control you wish to maintain
  • The desired presence in the local market
  • Your long-term business goals

Leveraging Local Expertise for International Growth

Although branches or subsidiaries can effectively facilitate global expansion, they’re not the sole options. Companies can also leverage local expertise through Employer of Record (EOR) services to expand their operations internationally or even consider partnering with an overseas company. EOR services enable businesses to maintain day-to-day control of supported employees, streamline international hiring processes, and ensure compliance with local labour laws.

However, EOR services also have their drawbacks. 

Due to service fees, they can be more expensive in the long run, and they offer less control over employees compared to a branch or subsidiary, which can impact company culture and integration. 

Additionally, relying on a third party for compliance and employment may introduce risks if the EOR does not fully align with the company’s standards or if local employment laws change.

EOR services, like Justworks and Rapid, offer the following benefits:

  • Expedite the hiring process
  • Handle paperwork
  • Comply with local labour laws
  • Pay employees in the local currency

This can be crucial for establishing a presence in new markets without the need for establishing a local legal entity, offering a flexible and low-commitment approach to international market entry.

Frequently Asked Questions

What is the main difference between a branch and a subsidiary?

The main difference between a branch and a subsidiary is that a branch is an extension of the parent company, while a subsidiary is a separate legal entity owned by the parent company.

Can a branch office enter into contracts?

Yes, a branch office can enter into contracts, with the parent company being fully liable for any issues faced by the branch.

What is an Employer of Record (EOR) service?

An Employer of Record (EOR) service allows businesses to expand internationally without establishing a branch or subsidiary. A third-party organisation takes on the legal responsibilities of employing staff on behalf of another company. This includes handling employment contracts, payroll, and taxes and ensuring compliance with local labour laws. 

An EOR service can be an alternative to setting up a branch or subsidiary. It allows businesses to hire employees in new markets without establishing a local legal entity. This can be a strategic option for companies looking to expand quickly with minimal risk and investment.

What are the main advantages of a subsidiary?

A subsidiary is an advantageous business structure because it offers legal protection for the parent company, operational autonomy, and the flexibility to adapt to local market conditions.

What are some of the challenges faced by branch offices?

Branch offices commonly face challenges related to sponsoring visas for employee transfers, hiring local workers, and establishing trust in local markets. Therefore, addressing these hurdles is crucial for their success.

Is a branch or subsidiary taxed?

Both branch offices and subsidiaries are subject to taxation, but the specifics vary depending on the country’s laws where they are located. Generally, a branch is taxed on the income attributed to its activities in that country, and the parent company may be subject to double taxation if there are no tax treaties in place. 

A subsidiary, meanwhile, is taxed as a separate legal entity. It is responsible for its own tax obligations, which can be beneficial if the country has lower corporate tax rates or offers favourable tax treatments.

Ensure Successful International Expansion with J. Dauman & Co

Whichever path you choose, it’s important to carefully consider your options and seek expert advice to ensure a successful international expansion. To navigate these decisions, consider partnering with J Dauman & Co, accountants with a wealth of experience in assisting UK businesses to flourish in the European market. Our dedicated team offers tailored advice to support your company’s growth and ensure a smooth transition into new territories. Reach out to J. Dauman & Co today to make your European expansion a reality.

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