Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
This article is part 11 of a 17-part series on global expansion. You can find the full list below this article.
If you’re thinking of setting up a business in another jurisdiction, you might be wondering what kind of physical and legal presence you should set up. On one hand, you might want to establish a branch or subsidiary office if you expect to have local employees and great aims for growth, but on the other hand, you might just want to start with something “lighter” to test the waters and see how attractive your products or services are in the new market before committing to something more “substantial”.
There are a handful of options you can choose from and each has its own pros and cons. Most companies choose to start with either a Representative Office or an Employer of Record (EOR) service, and then as their business grows they switch to a branch or a subsidiary. But if you’re not careful about which one you select in relation to what activities you are performing, you could find yourself in a pickle with tax and regulatory authorities.
And ignorance is no defense in an audit…
…so, keep on reading to learn more about the different kinds of physical and legal presence you can set up and which one will match your current and future needs!
The two common options for setting up a business in a new jurisdiction:
- Representative Office (“Rep office”)
A rep office is basically an extension of a head office in which you hire a local rep office manager to help raise the profile of your brand. From a legal standpoint, rep offices are extensions of the head office and are not separate and distinct legal entities.
The rep office manager has elevated responsibilities before other people are hired, and they are only allowed to engage in certain activities but not derive profit from these activities. The benefits of having a rep office is that you can start to generate brand awareness and your rep office can do market research and basic marketing.
But the rep office is restricted from making any sales, so if a customer wants to buy your product, then the rep office will have to refer them to the head office. A lot of companies don’t know this and wind up having a local representative make sales without the correct legal set up. If you have a rep office and rep office personnel are involved in conducting sales, then local government authorities could shut you down instantly and refer your situation to the tax authorities. They could then assess the existence of a permanent establishment and consequently how much of your revenue will be taxed in the rep office jurisdiction. Nowadays, less and less companies choose to set up rep offices in favor of an Employer of Record service.
- Employer of Record (EOR)
One of the downsides to having a rep office is that you cannot offer your local rep office employee benefits and employment security that they would qualify for if they worked for a separate legal entity. This makes it harder for companies to source talent, because anyone who joins a company would want market-level benefits and to feel comfortable supporting a company that has some sort of substantial, tangible presence in the jurisdiction.
That’s where Employer of Record (EOR) services can be a more effective option. You can hire people through an established company (weConnect!) within that jurisdiction and provide employee benefits, which makes this a great way to dip your toes into a jurisdiction without having to establish a physical legal presence yourself.
Plus, at a rep office, individuals and the company itself would be responsible for local tax compliance. But if you have EOR, then taxes can be prepared on behalf of the employees in a way that is smoother and with less confusion. Another benefit of EOR is that as long as you have the right tax and transfer pricing model in place, you can conduct any kind of business activity including sales. So you’re not as restricted about conducting business as you would be if you set up a rep office.
If you’re looking to get started in a jurisdiction with an EOR structure, we can help you with that, and you can contact us here.
The two common options for a more established physical presence in a new jurisdiction
There will come a point as your business grows where it’ll likely be more beneficial to switch from a rep office or EOR to a registered legal presence in the form of a branch or a subsidiary.
If you have a rep office, this typically would be the point in time where you recognize that a market exists for your product or service and there is a potential to realize sales, and you therefore want to have local employees undertake more sales-based activities.
If you have an EOR, this could be the point when you aim to hire more employees and want a more cost effective way to continue providing more employees with benefits while also showing more commitment to the market and therefore making recruiting top talent easier. The reason why EOR can be expensive is because the EOR takes on labor risk. So the more employees you have, the less the cost of operating your own branch or subsidiary is in comparison..
As a rep office or EOR, it’s impossible to sign legal contracts with other companies locally, which is another reason for switching to a different kind of establishment.
Now that you know why you’d want to switch away from a rep office or EOR, the next question is…what’s the difference between a branch and a subsidiary? Here’s a breakdown of each:
Depending on the jurisdiction, branches can be less expensive and easier to set up than a subsidiary. Legally, a branch is a separate physical office but an extension of headquarters’ legal entity. This also means that liability extends from the branch to the head office without limitation. A benefit of the branch structure is that there is no need for intercompany invoicing between the branch and the headquarters (as both are part of the same legal entity) and this can also facilitate the actual transferring of funds between the two. Funds can move freely between the branch and the headquarters and it’s just a matter of allocating the appropriate income and costs at the end of the year to ensure compliance with tax and transfer pricing rules.
- Subsidiary (separate legal entity)
One reason why a company would choose to set up a subsidiary over a branch could be that the subsidiary is a distinct legal entity separate from headquarters. For example, if you have a branch in a jurisdiction and there is a lawsuit, then legal liability would extend to the headquarters. But if you have a subsidiary, then legal liability would be limited to the subsidiary entity.
Another reason why companies choose subsidiaries is because it gives other companies the image that the company is committed to be physically and legally present in that jurisdiction for the long term. In Japan, for example, where relationship building is essential in conducting business, there may be more benefit to having a subsidiary instead of a branch to build trust.
One assumption people make is that setting up a subsidiary is expensive, but it’s actually not.
(Psssst…want to know some industry lingo? A branch has a head office, whereas a subsidiary has a parent company)
Insider strategies for setting up a business abroad
We’ll let you in on a little secret: recruitment companies really don’t like sourcing talent for companies that don’t have a legal entity set up in that new jurisdiction. What typically happens is that a company doesn’t want to create an entity until they have employees, which they know could take months. But then, if a recruitment company finds the perfect candidate swiftly, the company might lose that talent because they aren’t legally set up in a way in which they can hire people. It winds up being a waste of time and money for the recruitment companies to engage with new businesses unless they have the proper legal setup.
To mitigate this, weConnect can help you as an EOR in the interim, so you can start hiring people as soon as you decide you want to enter a jurisdiction until you have your entity set up. So, if you plan on creating an entity but don’t want to set one up until you have employees hired, it’s okay to have an EOR in the interim to get you started.
Keep in mind that you don’t necessarily have to take the same approach for each jurisdiction you enter. The kind of business you set up will depend on your needs at the time and what makes sense to your overall ambition and commercial strategy. For example, it is possible to have a global headquarters in the US with rep offices, EORs, branches and subsidiaries set up in other jurisdictions. You could even have your subsidiaries take charge of the rep offices and EORs within other jurisdictions. It’s essential to understand the relationship between each of these offices in your company network and all of the associated tax, legal and regulatory obligations each one has as well as the relevant interdependencies.
Not only have we seen these different kinds of strategies, but we have also seen companies switch from rep offices to EOR and branches to subsidiaries. We have also seen companies set up a subsidiary, realize it was more than they needed, and switch to a simpler EOR.
With special thanks to Sam Barrett from EY’s APAC Operating Model Effectiveness team for his inputs and insights in putting together this series of articles.
International Business Expansion Series
This article is part 11 of a 17-part series about International Business Expansion. Here’s a list of the full series to give you a well-rounded understanding of what to consider when expanding your business abroad, from strategy to execution to management:
- The #1 Thing that Companies Need for a Successful Expansion Abroad
- The 3 Components of a Market Analysis to Know if Your Product is Viable Abroad
- How to James Bond Your Profit Margin with Location Analysis
- How to WIN in a New Market with These 6 Models of Execution
- Risky Business: The 2 Key Layers of your Operating Model to Align with Your Growth Strategy
- Lost in Translation: How Culture Can Impact Your Business Expansion
- Show me the money: How to Fund Your Business Expansion Abroad
- You’ve Been Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
- Trash Talk: Why You Need to Analyze Your Processes Before Expanding Globally
- 5 Reasons Why You Should Customize Your Technology for Your International Expansion
- Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
- Landlocked: How your Transaction Flows can Impact Your Access to Funds
- 5 Industry-Specific Legal and Regulatory Obligations that can Impact Your Business Expansion Abroad
- “Health Checks”: Your Ticket to Building a Sustainable International Business
- How Much Is Your Business Worth? 4 Drivers that Increase the Value of Your International Business
- Plug and Play: How to Efficiently Scale Your Business When Expanding Abroad
- Beach, or Boardroom? Plan Your Exit Strategy Before You Expand Globally