Planning to expand globally but unsure whether to open a foreign branch or set up a foreign subsidiary? That’s a common dilemma businesses usually face when weighing expansion options overseas. However, setting up a foreign subsidiary is usually a safer option and this article tells you why. Let’s explore all aspects of this business strategy and why and when you should consider going down this route.
What Is a Foreign Subsidiary?
In its simplest definition, a foreign subsidiary is a company that operates in one country but is partially or wholly owned by the parent company that is based in another country. A foreign subsidiary is also known as a daughter company and is a separate legal entity that must comply with the local jurisdiction's tax and employment laws.
Let’s understand some of the pros and cons of establishing a foreign subsidiary.
Advantages & Disadvantages of a Foreign Subsidiary
Thanks to the explosion of global hiring and expansion beyond local geographies, businesses today are faced with exciting opportunities. Establishing a foreign subsidiary is one of the most effective ways to make inroads into a foreign market.
However, a foreign subsidiary comes with its own set of advantages and disadvantages and this is where a reliable Employer of Record (EOR) service provider can be of enormous help.
Setting up a foreign subsidiary as part of a global expansion strategy comes with several perks:
- Entry into new markets and access to talent: A foreign subsidiary opens the doors to new markets and creates opportunities for increased revenue that would otherwise not be possible in one’s local or home market. Sourcing local talent is a big advantage as it introduces new skill sets that could be missing in your setup.
- Local tax benefits: Saving on taxes is a massive benefit for the parent company. Since the foreign subsidiary is a separate entity, it only pays taxes to the local government in the host country. Often, these taxes are much lower than the tax rates in the home country.
- Lowered risk for the parent company: Since a foreign subsidiary is its own entity, the parent company faces zero legal risks of doing business overseas. In case the foreign subsidiary is sued by a third party, the parent company remains unaffected. Similarly, in case of any violation of local laws, only the subsidiary pays the fine and not the parent company.
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Diversification of workload: An intrinsic part of the global expansion of a business, foreign subsidiaries help divide a parent company’s workload enabling both, the domestic and foreign teams to focus on smaller, more specialized tasks. The diversification streamlines workload management, identifies new areas for growth, and helps the parent company achieve its business goals faster.
However, it's essential to acknowledge the potential drawbacks that come with such expansion. These include operational challenges, cultural gaps, and regulatory complexities. Awareness and management of these drawbacks are vital for companies venturing into international expansion. Let's explore these challenges and address how you can solve them. - Time-taking and expensive: Setting up a foreign subsidiary can prove to be an expensive and tedious exercise and a reason why many companies hesitate to branch out into global teams. The logistics involved can be massive, such as several months of research and a sizable upfront investment. A reliable EOR service provider makes this process simple and quick.Merely setting up a foreign subsidiary is not enough. The parent company also has to continue to invest enough time, manpower, and resources to ensure it is running smoothly. This could dilute their focus from other high-return activities.
- Not easy to dissolve: Not all foreign subsidiaries are a success. If this investment on the part of the parent company fails, and the foreign subsidiary needs to be dissolved, the subsequent process can be lengthy and costly. In fact, it could even take thrice as long to dissolve a foreign subsidiary than to establish one.
- Navigating cultural differences: Every country has its own unique culture, norms, and traditions and these could sometimes be at sharp variance with those of the parent company’s country. Such varying cultural norms could impact daily operations. The parent company has to, therefore, adapt to the cultural norms of their foreign subsidiary’s host country and be accommodating to make the arrangement work smoothly.
- Compliance risks: Compliance can be a tricky sea to navigate while setting up a foreign subsidiary. The whole process can be quite complex and calls for a thorough understanding of the foreign country's tax and legal systems. All of this can be quite overwhelming and, if one is not careful, can put the business at risk of non-compliance.
Legal and Financial Landscape of Foreign Subsidiaries
A foreign subsidiary is legally independent of its parent company and manages its own business operations. It has to comply with local taxation and employment laws of the country in which it has been set up, which could vary from its home country. Any issues arising from non-compliance, or a lawsuit or fine from local authorities, have to be faced by the subsidiary while the parent company retains immunity.
When Should You Set Up a Foreign Subsidiary?
Obviously, setting up a foreign subsidiary is not for everyone. It all depends on the long-term goals of a business
A company may consider setting up a foreign subsidiary if they plan to:
- Establish a long-term presence in a specific market
- Hire multiple employees in a certain foreign location
- Reduce the taxes they have to pay on global profits
- Hold physical assets in a specific market
Foreign subsidiaries prove viable only if the parent company has validated its target market and is ready to commit to long-term investments.
Alternatives to a Foreign Subsidiary
Are there any alternatives to setting up a foreign subsidiary? Yes, options exist for businesses that are keen on global growth but without establishing a foreign subsidiary. You may engage contractors to avoid setting up an entity or partner up with an EOR that specializes in international employment solutions. Let’s delve into these in more detail:
1. Engage independent contractors or freelancers
Engaging independent contractors to create a foothold in a foreign market without taking on the burden of entity establishment is a good alternative. This option gives benefits like cost savings, staffing flexibility, and reduced exposure to lawsuits. Independent contractors can be hired on a service fee and on a per-project basis as well. This enables organizations to leverage international talent without a long-term commitment.
2. Partnering with an Employer of Record
The second and more fail-safe option for expanding into a foreign market is to partner with an Employer of Record (EOR). By partnering with an EOR, a business can enjoy the benefits of entity establishment without getting drawn into the time-consuming registration process, massive upfront investment, and incurring compliance risks.
Enjoy Business Expansion Minus the Risks with a Reliable EOR
Partnering with an EOR is a great way to establish your footprint in a foreign country if you want to avoid all the nitty-gritty and hassles of compliance, investment, and logistics in a foreign land.
The fact of the matter is that many businesses cannot afford the time and resources required for entity establishment—especially if they plan to enter multiple markets worldwide. That’s where a reliable EOR like BGC can really help them achieve their business goals of expansion and growth without getting tied up in the legalities of compliance in a foreign land. BGC has a proven track record of helping businesses increase their speed to market, onboard and offboard international talent, and, most importantly, avoid compliance risks.
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