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If you have looked at the websites of companies that offer formation services, you might come away with the impression that setting up your company structure is one the vital first steps. But there is a reason I have left this to show 11, because until you know what your company is going to look like, what activities it will conduct in country, what activities will be outside the country, where you are likely to be located, what products or services you will sell, whether you will hire people, you cannot identify the legal structure that is right for you.
Now you have a good idea about what your business is going to look like, what are the options you need to consider when deciding on the best legal structure. For obvious reasons today’s show, like all shows, cannot be country specific, I have no idea which countries may be of interest to my listeners but will cover the most common options open to you, but do get specific advice from a local expert before taking any action.
Will your business be considered a permanent entity? - Usually defined as any commercial activity that is performed or generates revenue through a fixed place of business. Factors to be considered:
· Types of products or services offered
· Staffing levels
· Leased or purchased office space
· Contracts with local third parties – are they local to local?
If you trigger Permanent Entity or PE provisions you need a legal structure in your target country. A PE with trigger tax and reporting requirements that should be handled via a local business entity.
Understand your host country options:
· What options are available? Can be limited, for example China and Japan recognize fewer structures than most countries
· How does your selection impact the timing and requirements of entering leases, setting up bank accounts etc?
· Some countries require you have at least a leased location before they will allow you to register. Chicken and egg
The three most common options available are:
· Representative office
· Branch office
Representative office is the choice when you want to have a minimal presence in a country and only to conduct non-transactional activities. That is no selling. Setting up a representative office is usually simple and quite quick. The permitted activities of a representative office vary widely. For example in Singapore because a rep office lacks legal status the activities permitted are few It can only engage in activities such as conducting market research and feasibility studies.
Contrast that with Vietnam where a rep office can:
But revenue or profit generating activities are not permitted:
So once you want to go commercial you will need a branch office or a subsidiary
A branch office is an extension of the parent company and is not a separate legal or financial entity from its parent. But unlike a rep office it can engage in sales activities.
Some countries restrict some activities from working via branch offices – in Vietnam financial institutions credit rating agencies and commodity traders are not permitted to set up as a branch company.
Setting up a branch office can be quite cumbersome depending on the jurisdiction you are operating in.
A subsidiary is a legal entity in its own right – independent from the parent company. Like a branch depending on the jurisdiction it can be a large undertaking to set up a subsidiary in a foreign country. But because it is a separate legal entity it is a good choice for limiting the legal and financial exposure of the parent company’s interests. A subsidiary can be wholly owned by the parent company, a WOFE, wholly owned foreign enterprise in China, or partially owned by the parent company and a partner or partners.
Which is better for you? A branch or subsidiary?
As mentioned a subsidiary is a totally separate legal entity from your home company. It stands alone, it can be taxed, it can sue and be sued, it can be prosecuted if it breaks the law. But because it is its own entity there is a layer of protection for your home business. If the foreign entity become entangled in legal issues the liability lies with the local subsidiary not the parent or the holding company. It is difficult for parties or even governments to pursue action against the holding company for infringement committed by the local company.
Taxation could be another advantage. The subsidiary will be subject to the tax laws of the host country. This might enable you to manage your tax burden by taking advantage of favourable tax policies in the country and limit the impact of local taxes on the parent company’s profits.
Let's take an example. Assume that you are an American business and decided to enter the German market. You set up an office in Frankfurt to serve customers in Germany and surrounding European countries. And after review you decide a 100% wholly owned subsidiary is the best option for you. Although the German subsidiary is controlled by the US company it is taxed by Germany and subject to German laws. The German entity cannot be held liable for lawsuits filed against the parent company. And vice versa, the parent company cannot be held liable for actions of the German company.
When taxes fall due the German subsidiary pays taxes to German government.
If you had opened a branch office rather than a subsidiary the profits earned in Germany would be subject to US taxes. Any lawsuits brought against the branch would make the US company liable for damages or other penalties.
Taxes and legal liabilities are rather depressing. On the positive side if your subsidiary is successful and you receive an offer to buy it at a price you cannot refuse. It is a lot easier to sell the legal entity rather than enter an asset deal for sell the local operation. It is also a cleaner break for you, you leave behind any potential liabilities. Depending on the shareholders agreements etc of your company you may be able to sell the business without having to seek minority shareholders’ approval.
Another positive is that the local company may be able to take advantage of tax breaks and other incentives that are not available to foreign companies.
The pros and cons of each structure starting with a branch office.
Branch office pros:
· Usually easier to set up.
· A branch is part of the parent company and is managed directly the parent company. Decisions flow directly from HQ resulting in more control and faster implementation of the decisions
Branch office cons:
· No liability shield. The parent is liable for any issues that arise.
· Tax concerns. Depending on the laws companywide profits may be exposed to taxation in the country where the branch is located.
· Legal protection for the parent company
· The ability to take advantage of tax management strategies
· Credibility with banks, investors in the host country
· Compliance – the company may require multiple government regulations which can slow down the creation process. There may be minimum capital requirements and onerous reporting requirements
o The time required to set up a company varies considerably. According to the World Bank in New Zealand and Georgia you can have your company up and running in a day. In Hong Kong, Singapore, Canada and Australia it takes 2 day. The US 4 days the UK 5 days. At the other end of the scale – in Cambodia it will take 99 days, Laos 173 days and Venezuela 230 days. Also according to the World Bank the time to set up a company is falling. The global average in 2003 was 52 days. In 2019 it was 20 days.
· Political exposure. As you now you have a legal entity in a foreign country you will be exposed to any political actions of the host country’s government. Trade disputes being the most obvious risk.
Depending on the country there will be various options for your company structure. Requirement will vary from country to country but some of the typical conditions are:
1) A registered address – this is required in most countries
2) Minimum capital. This can vary widely. In France if you want to set up a Public Limited company or SA you need a minimum capital of 37,000 Euros, whereas in neighboring Holland there is no minimum capital needed.
3) Company Secretary – Some countries such as Singapore you must have a qualified company secretary, in other countries a director can fulfill the role, some countries do not require you to have a company secretary.
4) Minimum number of shareholders Often only one is required, but some countries need 2 or more
5) Number of directors – again often only one is needed. But many countries do require that you have a resident director. That is a national or sometimes a permanent resident of the country concerned. Where there is this requirement there are usually firms that will provide this service. But they will charge a fee so shop around.
In return of this you get legal liability limited to the value of the shares issued. I have known some large multinationals operate in countries with a share capital of less than $100.
Some countries will require you to capitalize the amount of your investment. If you are building a $2 million plant you will be required to have a company capital of $2 million. The logic is that the government wants you to retain the value of your investment in the country not expatriate as cash/dividend.
Intellectual property is an important consideration as not all countries protect IP as rigorously as many western nations. If you have a research facility in a foreign country ensure any IP developed by your employees becomes company property. Ensure employment contracts, confidentiality clauses etc. are vetted by someone knowledgeable on the subject.
Keep in mind many countries will only protect your IP if you take precautions to protect it yourself. If you openly discuss IP with all your employees rather than limit it to those who need to know you are at risk of not being able to enforce your IP rights later.
An aspect of IP you should consider is the potential to license your home based IP to the overseas subsidiary. This is a means to expatriate profits back home. The license fee must be reasonable based on the value of the IP concerned. As a guide consider how much you would charge a third party to use your IP. This is a complicated subject and it would be best to seek professional advice. But done correctly license fees should be tax deductible in the host country.
A related topic is transfer pricing. Goods and services provided by the home company should be sold to the host country at arm's length pricing. Often these are not services you sell so determining arm's length pricing can be a challenge. Google transfer pricing and you will find over 700 million hits.
Management and Corporate accounting. If you use licensing and transfer pricing the local companies accounts will be impacted by the profit element of these charges. So you may want to consider two sets of accounts. Corporate accounts which include these costs and Management accounts that exclude the profit element. The Corporate accounts will be used for statutory reporting, the management accounts to evaluate the performance of the subsidiary and its management.
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