Opening A Foreign Subsidiary 101

If your business is looking to expand abroad, then you’re probably considering opening a foreign subsidiary. As you may know, a foreign subsidiary is an established entity that a parent company owns in a different country.

Deciding whether to open a foreign subsidiary is a major business decision. In this article, we provide an overview of what a foreign subsidiary is, as well as the pros and cons of establishing this type of entity in another country.

What is a foreign subsidiary? 

A foreign subsidiary is an offset of a parent company in another country. The subsidiary has the ability to conduct business for the parent company in a foreign country. Subsidiaries can act as the employer to the parent companies employees abroad. 

What is the relationship between the parent company and its subsidiary?

The parent company of a subsidiary is the holding company of that entity. Parent companies with less than 50% ownership in the entity are known as affiliate companies. 

Although there are different types of subsidiaries in each country, the parent company will almost always still have some say in how business is conducted and who is involved in the management of the foreign entity.

How the business operates will depend on how the parent company has chosen to set up the subsidiary. For instance, subsidiaries may be just one offset of the parent company. Alternatively, companies might have multiple subsidiaries spread out around the world, each with different business activities and purposes.  

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

If you’re planning to expand your business in a new country, you will normally have the option of choosing between opening a branch office or establishing a foreign subsidiary. 

Branch office

A branch office is an outpost of the parent company that is located in a different country. A foreign branch office is almost completely reliant on the parent company. The key goal of a branch office is to run all of the parent company’s business in that country. 

You also need to have a permanent establishment to conduct business out of a new jurisdiction. If you’re operating an organization’s branch office abroad, you will need to comply with more laws and regulations than what is required for running a foreign subsidiary. 

Subsidiary 

A subsidiary, on the other hand, operates as a separate legal entity from the parent company and is similar to an LLC in the United States. The parent company will have some stake and control of the subsidiary, but the subsidiary has more freedom and autonomy, especially when it comes to how the day-to-day operations are handled. 

5 advantages of opening a foreign subsidiary 

1. Independence from parent company 

When you choose to open a subsidiary as a limited liability company, the parent company will have a lot less control over the entity. This gives the foreign subsidiary the advantage of molding operations in a way that better aligns with the culture and business practices of the new country.

By choosing to open a subsidiary in a foreign country, you are giving the entity more control over how daily business is conducted. 

Whether it's a wholly owned subsidiary (another company owns 100% of the stock) or a majority-owned subsidiary (51%-99%), the foreign entity has a lot of freedom, as long as the entity generates the necessary profits. 

2. Limited liability for parent company 

As the parent company, if you choose to open a limited liability subsidiary, you are protecting yourself from any debts that the foreign entity may incur. Opening a subsidiary in another country means you are only responsible for your initial capital investment.

Although you will still have some stakes in the subsidiary, if anything were to go wrong, the parent company won’t be held as legally responsible. This gives your business a bit more independence. After all, you can’t be there in-person managing all of the operations of the foreign subsidiary. 

3. Access to more global markets

As your company begins to expand, you will probably want to take your business international. Making the jump to open subsidiaries in other countries gives your business the ability to grow your customer base and increase your number of trade options.

4. More credibility 

With access to more global markets and a larger business, you will also build your credibility as a company. The wider your reach around the world, the more likely people will take your product and company seriously. Showing that you have the financial means and time to expand demonstrates that your business is doing well enough to grow outside of your home country, which can be appealing to customers and investors alike. 

5. Access to more talent

Choosing to open foreign subsidiaries also means that you will have to hire employees in other countries, which is a great approach for diversifying your global workforce. 

A larger talent pool means new ideas. This can help make your company more relatable to a wider customer base. 

If you’re not sure if opening an entity or subsidiary is the right move for your business, consider hiring employees in new markets by partnering with an EOR service like Justworks.

5 disadvantages of opening a foreign subsidiary 

1. Unpredictable costs

Opening a foreign subsidiary in another country will take time and money. You will have to account for travel back and forth to the foreign country, local accounting and legal fees, and upfront capital investments. In some countries, you will need to meet a minimum capital requirement, per federal subsidiary laws. Plus, you’ll need to pay your management team. 

2. Learning new employment and tax laws

You will still need to understand all of the regulations governing that specific country, which also means hiring an HR department to manage your foreign subsidiary. To avoid running into compliance issues, you will need to understand what compensation and benefits employees are entitled to (such as paid time off) and make sure that you are properly paying your employees. 

Navigating global payroll, employee benefits, and taxes can be complex. For this reason, many companies partner with global payroll service providers (like a PEO or an EOR) to do the heavy lifting. 

3. Building a strong legal team 

Another disadvantage of opening a foreign subsidiary is that you will need to hire a legal team that has in-depth knowledge about the laws and taxes governing the country you’re expanding to in order to avoid any compliance issues. If the subsidiary is owned and controlled by a foreign business, which is usually the case, challenges with international tax laws can arise. 

Sure, you might know how to comply with federal laws. However, to ensure compliance, a local legal team is necessary to ensure that your team is remaining compliant with state or province level regulations. 

Easy-to-miss nuances in the country’s foreign subsidiary laws can cost your business thousands of dollars in fines and legal fees.

4. Cultural differences

While working with people from different cultures has key advantages for businesses, such as building deeper empathy with your customers, cultural differences can also lead to misunderstandings, poor communication, and confusion. 

Tailoring your business practices and operations to a new culture can be challenging, especially if you don’t have a team of on-the-ground experts. For this reason, you want to make sure that your product has a strong fit in the new country – what sells in Mexico won’t necessarily sell in China, for example. 

5. More bureaucracy 

To open an international subsidiary, you will have to register with a number of bureaucratic structures in the new country to legally and compliantly start running your global business. In most cases, you will need to form a board of directors. 

Most countries also require foreign subsidiaries to open a local bank account in order to compliantly pay foreign workers as their employer. In some cases, you will need to file paperwork in person and cut through even more red tape. 

Is a foreign subsidiary right for you?

Opening a foreign subsidiary has a lot of great benefits for companies hoping to expand their market internationally. You will have new access to a new talent pool and a wider customer base. Most importantly, if you open a subsidiary as a local operation, it can operate as a complete local entity. 

However, if you’re just planning on hiring new talent abroad or want to just test the waters in another country, using a global EOR service like Justworks is the best option for expansion. EOR’s already have established entities and legal teams in foreign countries. If you already have an entity established abroad, then you might consider working with a professional employer organization, or a PEO.

How Justworks Provides International EOR Services for Small Business

Through Justworks, you can now expand the boundaries of your talent search without setting up a local entity. Focus on building your team, and leave worrying about the nitty-gritty of HR and international compliance to us. 

Our team of local labor lawyers and experts ensure that your small business always remains compliant while expanding internationally. We handle the responsibility side of things so you can focus on what matters: managing your team. 

Learn more about how you can expand your international business through Justworks, and get started today. 

FAQ

What is an example of a subsidiary company? 

A subsidiary company is set up by a controlling parent company. Examples of subsidiary companies are Walt Disney owning Marvel. 

How do I set up a subsidiary abroad? 

To set up a subsidiary abroad, you will need to decide between a branch office or opening up an entity in that country. Both options have their advantages and disadvantages. Then, you will need to register and pay the fees associated with opening a subsidiary in that specific country as well as follow all the necessary rules and procedures depending on where you plan to expand to, and how much you are looking to invest. 

What is a foreign subsidiary example? 

The most famous example of a foreign subsidiary is 7-Eleven in Japan that is owned by the parent company 7-Eleven in the United States. 

What is a permanent establishment?

If a company or business has a stable presence in another country, they must pay local and federal taxes where they are based. Simply put, a permanent establishment means your business presence is taxable. However, there can be tax benefits, depending on the specific country’s local subsidiary laws.