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The Pros and Cons of Setting Up a Foreign Subsidiary

For any company contemplating expanding into a new market, the advantages and disadvantages of setting up a branch or foreign subsidiary will depend on the business opportunities, as well as the cultural and regulatory climate of the specific country.  There are challenges associated with overseas expansion, and while some business issues are universal, such as complying with payroll regulations, other elements are more country-specific and require research into potential solutions to prevent unexpected delays or costs.

The Pros and Cons of Setting Up a Foreign Subsidiary

Setting up a subsidiary in a foreign country can have many positive effects such as expanding brand recognition, opening access to new markets and using efficient production methods to control costs.  Entering a new location can mean increased revenue and business expansion that would not be possible in the home country.

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However, in order to initiate a worthwhile venture in each new country, a company must consider factors such as:

  • Cost and time to establish a foreign subsidiary
  • Corporate policy toward compensation and other HR issues
  • Compliance risk for payroll, taxation and immigration rules
  • Establishing secure office premises, employee residences and bank accounts
  • Evaluating the growth potential against the required investment
  • Permanent establishment issues resulting in taxable local revenue
  • Contingency plans in the event that the new foreign office needs to be closed

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Reasons to Establish a Foreign Subsidiary or Branch

There are eight reasons that could influence the establishment of a foreign branch. These reasons will be illustrated in the following paragraphs by identifying the advantages and disadvantages that could arise from establishing foreign subsidiaries in specific countries or regions.

1. Opening Up Access to New Markets For Products and Services

Entering a new region can open up access to multiple markets in neighbouring countries.

European Union

Pro: The European Union is one of the world’s largest and most sophisticated markets, with all member countries adhering to various business and immigration rules for consistency and ease of travel.

Con: Taxation of foreign businesses will differ depending on local country rules as well as whether the business is from a non-EU country.  Naturally, with so many different member states, there will be language and cultural challenges in expanding into each new European country.

2. Expanding Brand Recognition

By opening a branch in a new country, a company has the opportunity to expand the reach of their brand.

USA

Pro: The USA attracts businesses from all over the world that are looking to participate in the open business environment and large, visible economy.  Foreign businesses can benefit from the relatively strong market for products and services, as well as introducing and marketing new brands.

Con: The USA is well known for its stringent immigration policies, and that includes the issuance of business visas for foreign workers.  There are an array of visa types depending on the type of employee, profession and current immigration status, and as many as three different agencies may be involved in approving the application.

For each foreign worker, a company must submit Form I-9, which establishes the identity and origin of the worker, including residency or existing visas.

3. More Cost-Effective Production and Manufacturing

There are advantages to setting up a foreign subsidiary in another country where there may be a cost-effective manufacturing and production industry

China

Pro: The manufacturing and production industry in China is cost-efficient and therefore has the capacity to minimize overall production costs for companies.

Con: China has a number of strict requirements for both work permits and visas for foreign workers.  The primary hurdle is the need to have a locally licensed and incorporated business in place before work permits can be issued.  The “Z” business visa can take up to six weeks for approval, delaying entry for work purposes.

4. Access to Technical Skills / Regional Knowledge

Some foreign countries have greater access to advanced technology and are more adept with technical skills.

Japan

Pro: Japan continues to attract interest from businesses that are looking to expand in the Asia-Pacific region.  There is a strong history of international business cooperation in the country, as well as a high level of technical knowledge in some industries.

Con: As with many Asian markets, there can be challenges with both cultural and language barriers, given that Japan has a very specific etiquette of how business is conducted.  Also, English is not as widely spoken as in some countries, and there may be communication issues.  Tax issues are complex and need to be fully researched ahead of time.

5. Customer Service Centers

Multinational companies with established international customers may need to open a foreign branch office for customer service reasons, and will look for a business friendly location for that purpose.

Switzerland

Pro: Switzerland might appear to be an ideal location in Europe for this purpose as it boasts high ranking in various measures including government transparency, civil liberty, and economic competitiveness, and is ideally situated to serve customers in other European markets.

Con: For a business that wishes to set up a branch office or subsidiary in Switzerland there is the challenge of complex tax rules for foreign companies.  Certain types of liaison offices do not have to register for or pay income tax or VAT.  However, the rules are different for subsidiary companies, since some types will be exempt from VAT but may have to pay a Stamp Tax.

6. Part of a Global Expansion Plan

 Some countries serve as an excellent base, enabling the foreign company to expand into the region.

Saudi Arabia

Pro: As the largest economy in the Arab world, Saudi Arabia is an attractive location for business expansion and investment into the region.  The incorporation process has been streamlined for foreign companies that wish to set up a branch office, although there are still minimum capital requirements.  There is no limitation on foreign ownership of subsidiary companies, as long as the capital and registration requirements have been met.

Con: Due to the many non-Saudi workers in the oil industry, there have been some measures to limit the presence of foreign workers. However, they have not been strictly enforced.  There are specific employment laws on reasons for termination of workers, and termination without cause may result in compensation for the employee and reinstatement.

7. Use of Free Trade

Free Trade Zones allow companies to easily maneuver into foreign countries without facing extensive barriers to entry.

UAE

Pro: The UAE promotes itself as a business hub in the Middle East, and there are many opportunities available to foreign companies looking to start a subsidiary.  There are various free trade zones available to certain business types, which can make the entry process easier for some companies in the permitted industries.

Con: To set up a foreign subsidiary in the UAE, a local partner must have a 51% ownership stake, unless the business is conducted in one of the free trade zones.  The UAE is also a costly location for expansion due to capital investment requirements, licenses, visas, registrations and real estate values.

8. Participating in Local Economic Opportunities

 A foreign country can offer a business the chance to profit from local economic trends.

Algeria

Pro: As a center for oil and gas production, Algeria offers opportunities in infrastructure, engineering, construction and telecommunications.

Con: The exchange control laws may be especially problematic for businesses with the transfer of incomes and revenue, or liquidation of direct foreign investments.  This is further complicated by laws that require a 51% Algerian ownership interest in foreign investments, and a 30% stake in foreign owned import businesses.

What Is Involved in Closing Down a Foreign Subsidiary?

If the expansion into a new market does not meet expectations, then it may be necessary for a company to close down a foreign branch or subsidiary.  While the more obvious tasks of repatriating employees to the home country may be straightforward, there are other issues that must be attended to in the process such as:

  • Obtaining funds from any capital investment requirements
  • Re-negotiating office leases that may have early-termination penalties
  • Payment of vendors or local suppliers for products and services received or under contract
  • Final payroll administration, withholding, taxes and other contributions
  • Transfer of office equipment, files and documents
  • Securing electronic data and files
  • Closing of bank accounts and terminating other professional services

These steps can be simplified if the payroll, tax and immigration processes were being handles by a GEO service, and then the company would only need to facilitate transfer of employees and physical assets.  For this reason, many companies decide to use a GEO service for the initial entry into a country, which allows for more rapid deployment and minimizes the risk and financial exposure while testing the new market.

 The GEO Employer of Record as an Alternative to Setting Up a Subsidiary

While some companies can justify the time and expense of setting up a foreign subsidiary, there are many instances where utilizing a GEO local employer of record is a better alternative.  The GEO already has a legal entity in place that can handle all aspects of payroll, employment and immigration requirements in the host country.  The local employer of record is an intermediary between the client-company and assignee, and has the network and expertise to ensure full compliance with all laws and regulations.

Shield GEO

One of the benefits of the Shield GEO service is our broad experience in many different countries, assisting clients with company set-up, payroll, immigration laws and tax compliance for employees.  For many companies, using a GEO service allows for a more cost-effective and quicker entry to the new market, and if the venture is successful then they can transition to a DIY approach over time.

We evaluate each client scenario independently, and offer solutions that are customized for your business and expansion needs.  Our approach is country-specific and we have identified the key benefits and challenges for a company expanding into a few of the more favored global locations for new business entries.

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