The Differences Between Subsidiaries and Branch companies
Subsidiaries and branch companies are important forms of business organization of large modern companies. Why does a company arrange some of its affiliates as subsidiaries and others as branches? Subsidiary and branch, which is the best choice for a company when setting up affiliates? Before answering these questions, let’s take a look at the characteristics of branches and subsidiaries.
( I ) Branches:
The relationship between the branch and the parent company is similar to that of the subsidiary and the parent company. However, the legal status of a branch is completely different from that of a subsidiary. It does not have an independent legal status.
A branch company is a branch or affiliate directly under the head office that conducts business operations. Although the branch company has ‘company’ in its name, it is not a real company. Because the branch company does not have the legal personality of an enterprise, it does not have an independent legal status and does not independently bear civil liabilities.
Benefits of setting up a branch:
- (1) Branches are generally easy to operate, and the requirements of the financial accounting system are relatively simple.
- (2) The branch company’s cost and expenses may be lower than the subsidiary’s.
- (3) The branch company is not an independent legal person. The turnover tax is paid in the locality, and the profits are combined with the head office for taxation. In the initial period of operation, branches often suffer losses, but their losses can offset the profits of the head office and reduce the tax burden.
- (4) The profit that the branch company delivers to the head office usually does not have to pay the withholding tax.
- (5) Capital transfers between branch companies and head office does not have to pay taxes, because they do not involve changes in ownership.
It can be seen from the above that there are significant differences in the tax benefits of subsidiaries and branches. Companies should carefully compare, consider and plan correctly when choosing the organizational form. However, the most important difference between the two organizational forms is that:
- Subsidiaries are independent legal entities that are considered as resident taxpayers in the setting-up country and usually have to assume the same comprehensive tax liability as other companies in the country. A branch company is not an independent legal entity, and is regarded as a non-resident taxpayer in the country where the branch company is established and only has limited tax liability. The profit and loss incurred by the branch company shall be calculated combining with the head office, that is, the ‘consolidated statement’. China’s tax law also stipulates that a company’s subordinate branches have two forms of payment: One is the independent declaration of tax payment. The other is consolidated into the parent company to pay tax. Which form of taxation will be used will depend on the nature of the company’s subordinate branches – whether it is an independent taxpayer for corporate income tax.
- It must be pointed out here that the calculation of the combined profits of overseas branch companies and head office companies affects the tax burden of the country of residence. As for the host country where the branch company is located, it is still necessary to tax the income that belongs to the branch company itself. This is the so-called implementation of the revenue source tax jurisdiction. However, a domestic branch company does not have this problem. For this, companies should pay attention to tax planning.
( II ) Subsidiaries
Subsidiaries are legal concepts that corresponding to parent companies. Subsidiaries have legal personality and can independently bear civil liabilities. This is an important difference between subsidiaries and branches.
The parent company and subsidiaries are both independent legal entities and the subsidiaries are actually controlled by the parent company. According to the majority vote principle of the shareholders’ meeting, the more shares there are, the more the right to make decisions on the affairs of the company. Parent company controlling subsidiaries usually means equity-based possession or control agreements.
The parent company has actual decision power over all major matters of the subsidiary company. Of particular importance is the ability to determine the composition of the subsidiary’s board of directors. In addition to the way of shareholding control, the formation of certain special contracts or agreements that allows a company to be under the control of another company, may also form a parent-subsidiary relationship.
Benefits of setting up a subsidiary:
- (1) There is also only limited liability in the host country (sometimes requiring parent guarantees).
- (2) The reporting of the results of the subsidiary company to the parent company is limited to the production and operation activities, while the branch company must report the overall situation to the parent company.
- (3) Subsidiaries are independent legal persons and their income tax assessments are conducted independently. Subsidiaries can enjoy preferential tax treatment including tax holidays for the resident companies of the host country, while the branches are mostly reluctant to be provided with more concessions by the host country because they are sent abroad as part of the company.
- (4) When the host country’s application tax rate is lower than the country of residence, the subsidiary company’s accumulated profits can receive deferred tax benefits.
- (5) The repatriation of subsidiary profits to the parent company is much more flexible than the branch company. This is equal to the parent company’s investment income. capital gains can be retained in the subsidiary, or can be repatriated when the selected tax burden is lighter, and obtain additional taxes interest.
- (6) Many countries provide the reduction or exemption of withholding tax on dividends paid by subsidiaries to their parent companies.
( III ) Differences in taxation
The establishment of a branch company and a subsidiary through share control has very different taxation regulations. Since the branch company is not an independent legal person, the profits and losses it realizes must be combined with the parent company to calculate and pay tax. The subsidiary company is an independent legal person, the parent company and the subsidiary company should pay taxes separately, and the subsidiary company can only distribute dividends according to shares held by shareholders from after-tax profits. In general, setting up a subsidiary is more advantageous if the company formed can be profitable from the beginning. In the case of a profitable subsidiary, various tax incentives and other business benefits offered by the local government can be enjoyed. If the company formed loses money in the early stages of its operations, it will be more advantageous to form a branch company that can reduce the tax burden of the head office.
Subsidiaries and branch offices are important forms of business organization of large modern companies. Why is a company arranging some of its affiliates as subsidiaries and others as branches? This probably should be analyzed from the perspective of tax planning, because under the increasingly fierce market competition, all legal measures that are conducive to improving the economic efficiency of enterprises are the focus of the company’s consideration. Selecting an organizational form that is conducive to tax incentives is one of the important ways to achieve this goal.
Countries around the world ( including China ) have many different regulations on the tax treatment of subsidiaries and branches, which provides a space for companies or multinational corporations to choose a form for setting up affiliate organizations.