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Branch or Subsidiary

A branch is an office through which a foreign company engages in business. The branch has no independent legal personality (although it is treated in some respects as though it were independent for tax and foreign financial relations purposes). It follows that the foreign company is directly and fully responsible for all liabilities and undertakings of its branch office.

The subsidiary company, on the other hand, is a separate legal entity. It is an independent entity from the foreign parent company shareholder and, in principle, shareholders have no liability for the debts or undertakings of the subsidiary, the recourse of the subsidiary’s creditors or co-contracting parties being limited to the assets of the subsidiary.

As a practical matter, even where group financial standing and corporate policy effectively excludes the possibility of a subsidiary’s bankruptcy, the existence of limited liability at the subsidiary level – involving the theoretical but legal possibility of leaving the subsidiary’s creditors, employees, tax office, etc. with no recourse beyond the subsidiary’s assets – may permit a favorable negotiated solution which would not be possible where there exists no legal possibility of limiting liability to the subsidiary company’s assets.

Some country´s laws permit ensuring essentially the same measure of parent company control over a subsidiary as that of head office control over a branch office.

The subsidiary offers a somewhat greater measure of flexibility in the sense that, as opposed to the branch office, it may issue or transfer shares to third parties (partners, investors, venture capitalists, managers, employees or other group companies within the framework of a reorganization or joint venture). It may also issue bonds or shares to the public and obtain quotation on a stock exchange.

On the other hand, the subsidiary form renders applicable a law entitling employees to profit participation when the company’s activities reach certain levels.

Psychological considerations

Despite the generally greater security that a branch form accords to creditors, by reason of the direct legal liability of the foreign company, in practice local government administrations, banks, suppliers and customers frequently seem to feel more comfortable dealing with a locally incorporated company (although they may nonetheless request the foreign parent’s guarantee).

Tax considerations

Both branch and subsidiary are generally subject to local company tax on their net profits, the rules applicable being often essentially the same.

There remain, however, several differences in several countries:

• A branch office is taxable on income effectively connected with its activities (no tax being due on unrelated local source income of the foreign company); a subsidiary is taxable on its entire worldwide income except that which is effectively connected with a branch office outside Fthe local country. Nothing, however, prevents the foreign company from directly engaging in transactions in the local country in which the subsidiary or branch is not involved;
• A branch office is not permitted to deduct royalties paid to its foreign head office or interest on loans from its foreign head office; head office source financing may, however, transit through another group company or, in the case of financing, through a bank, in which case the relevant royalties or interest may be deducted; in the case of a subsidiary, there is a limit upon the deductibility of interest paid to the parent company based upon the ratio of loans to capital; indirect loans may also escape from these limits;
• If the losses of a subsidiary company exceed one half of its capital, certain measures must be taken to make third parties aware of that fact and to remedy the situation within a two-year period. No such obligation exists for a branch office.
• Local country source income booked by a foreign head office must be included in the local country branch’s taxable income if such income is “effectively connected with” the branch office’s operations.
• A branch may deduct a reasonable allocation of head office administration expenses. In the case of a subsidiary, a deduction is only permitted for clearly identified administrative services invoiced by the parent or other group company;
• No value-added tax is due upon services invoiced between a head office and a branch. For example, since companies outside the European Union cannot deduct VAT paid unless they export goods to the European Union, there are certain cases in which using a branch rather than a subsidiary to render services would effectively reduce the amount payable by the foreign company.
• Depending upon the rules for fiscal consolidation applicable in the country of the head office, branch profits may be taxable in such country and branch losses may be deducted from head office profits; this factor sometimes leads to choice of structure where losses are initially anticipated.
• The fact that the head office and branch are the same legal person permits the local tax administration to require submission of the head office accounts and other information (and thus be in a better position to challenge allocations or interoffice transactions);
• A subsidiary benefits from the provisions of the tax treaties existing between the local country and other countries, this is generally not the case for a branch office (which in some cases also may not benefit from the provisions of the treaties concluded by the country in which its head office is located);
• There exists a  “distribution tax” on branch after-tax profits; this tax is reduced or eliminated by most tax conventions (following the OCDE model); when due, the distribution tax is collected annually together with tax on corporate income, it can be refunded upon submission of proof that the foreign company paid no dividends relating to the year in question;
• In the case of non-reimbursable funds made available by a parent to a subsidiary other than through a capital increase (often called subsidies), the amounts in question are treated as taxable income of the subsidiary and are, in addition, subject to value added tax  if the subsidy is considered “commercial” as opposed to “financial” in nature.

Concerning transformation of branch into subsidiary (and vice-versa)

The contribution in kind or transfer of the assets and activities of a local branch of a foreign company to a local subsidiary of that company may give rise, depending on the countries, to both a transaction tax  and capital gains tax, the tax basis for which may include a goodwill element based upon the branch’s turnover.

In certain cases, a tax-free contribution may be possible; however, it may, depending upon the circumstances, require a tax administration ruling and effective limitations upon the right to transfer the subsidiary’s shares during a three-year period.

The transformation of a subsidiary into a branch office of a foreign company can also be envisaged within the framework of a European reorganization. Once again, there may be local tax consequences, and a ruling may be required in order to avoid taxation of capital gains.

The transformations may also give rise to tax consequences in other countries whose entities participate therein.

If the likelihood of a later transformation is anticipated at the time of the initial investment, the potential tax consequences of transformation should be examined, particularly if it is expected that the branch or subsidiary’s business will become highly profitable.

Cost considerations

Although filing fees are approximately the same, the costs of establishing a subsidiary will be somewhat higher by reason of the additional paperwork represented by the preparation of articles of incorporation, etc. However, registering a branch requires a local translation of the company’s Articles of Incorporation, and the difference in establishment costs remains relatively modest.

There is also a minimum capital requirement in the case of most subsidiaries, while no minimum amount need be invested in a branch office. The minimum capital an S.A., S.A.S. or S.A.S.U is € 37,000, of which at least 50% must be paid up at the time of incorporation. S

As opposed to the subsidiary, no annual legal and registration fees are required (in connection with shareholder and board meetings) other than upon the occasion of changes of the branch manager, branch office, etc.

Annual branch filing requirements are somewhat more onerous since they bear upon both the foreign company’s accounts and the branch’s accounts.

On net balance, the branch is somewhat less expensive. The amounts involved however, are such that they would not normally control the decision as to the structure to be employed.