Many American business owners expand their operations internationally without stopping to ask if they need a foreign branch or subsidiary.
They’re often shocked to learn the consequences of both.
Fixing mistakes doesn’t come cheap. Here are some key points to know before creating a foreign branch or subsidiary.
Branch
Generally, a branch is a permanent establishment or fixed place of business through which business is conducted. A foreign branch can be anything from an office to a manufacturing plant.
A foreign branch can exist without creating an entity.
The legal definition of a branch is different for each country making it imperative to understand the consequences of your presence there. Planning is essential.
Branches are notoriously easy to create. Hiring a contractor who works from home or hosting your e-commerce store’s website on servers located in a country may be sufficient to create a branch in some countries.
Most countries require that branches be reported to assist with tax compliance. Income is attributable to a branch and is generally taxed by the country in which it is located. Allocating revenue and expenses to a branch can be extremely difficult as it is often not clear what income and expenses are allocable to the branch. To make matters worse, the branch country and home country will often try to have more profits allocated to themselves to increase their tax revenue.
Subsidiary
Foreign subsidiaries are only created through the creation of a separate legal entity in another country.
This is often necessary to open a bank account in a foreign country, acquire insurance, employ workers, or rent/purchase office space.
But creating a foreign entity typically triggers reporting requirements not only in the foreign country but with the IRS as well.
Many business owners are surprised to learn the costs of owning a foreign entity which may include annual company renewal fees, withholding tax, audit requirements, and tax compliance monitoring.
Converting A Branch To A Subsidiary
Many business owners desire to create a subsidiary after learning they inadvertently created a branch or desire to expand there more fully.
Tax reform in 2017 made it so any gains that occur in a conversion are taxable. Additionally, the transfer of goodwill, going concern value, and identifiable intangible property is treated as a contingent sale of property in the amount commensurate with the income they generate. There are also Subpart F (statutory attribution of profits to the shareholders) and GILTI (a minimum tax on world-wide operations payable by the shareholders) tax considerations that must be made.
Failure To Comply
Failing to comply with branch and subsidiary reporting requirements can be extremely costly. International tax matters often come with enhanced fines and penalties.
Getting up to date with taxes owed and all reporting requirements usually involves highly specialized and costly tax advisors.
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