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What is a Subsidiary?A subsidiary is a business owned by a ‘parent company’, but ultimately acting as a separate entity. Sometimes, subsidiaries are referred to as ‘daughter companies’. The parent company has a whole or majority ownership stake.
Establishing a subsidiary rather than an overseas branch means less responsibility for the parent company. A subsidiary reports to a ‘holding company’, not necessarily the organisation that set it up; in fact, the business of the subsidiary may be entirely different to that of the parent company.
The parent organisation also has no liability for the subsidiary, as it is considered a separate legal entity. If a subsidiary is involved in any kind of litigation, liability is limited solely to the subsidiary.
Finally, the accounts of the parent organisation and the subsidiary are managed separately. If the subsidiary loses money, it doesn’t necessarily need to be closed, but can be sold instead to another company.
Why might a UK-based company want to set up a subsidiary abroad?There are a vast array of reasons for wanting to set up a foreign ‘daughter company’. If the subsidiary is intended as an extension of the UK business, it may offer access to new markets for products or services.
Alternatively, the overseas location may provide opportunities not offered in the UK: for example, lower manufacturing costs or increased technological capacity. Countries such as Japan provide access to advanced technology that we simply don’t have in the UK.
Some of these perks can be enjoyed without the need for a subsidiary: an independent contractor could be employed to carry out business operations overseas, or the UK company could join forces with an existing company overseas.
Setting up / Acquiring a SubsidiaryForeign subsidiaries can be set up from scratch in a new international location, or they may involve a merger with, or acquisition of, an existing company.
Perhaps an opportunity arises to acquire a reputable foreign company whose values and product offering align with those of the UK company. Acquisition of such a company could bolster the credibility of both companies, while providing the UK business with valuable industry connections abroad.
Alternatively, a subsidiary may be set up by the parent company in a country where there is perceived opportunity for long-term growth. Perhaps the market for a particular product or service is saturated here in the UK, while demand remains high elsewhere.
Businesses that plan to have a long-term presence in a foreign country often opt to set up a subsidiary because the benefits outweigh the risks. In these situations, the time and expense of setting up a foreign subsidiary can be justified by the greater flexibility that having a separate legal entity provides.
Rules & RegulationsThere are some prohibitions when it comes to owning a foreign subsidiary that it’s important to be aware of.
Some countries regulate certain industries and prohibit foreign ownership. In some situations foreign ownership is absolutely prohibited, while in others, ownership must primarily be local but a foreigner can invest a certain percentage into the business.
Industries where majority domestic ownership is mandated include airlines in the European Union and North American countries, telecommunications in Japan, and coastal and freshwater shipping in the United States. Foreign ownership is entirely forbidden in the fishing and energy sectors in Iceland, and in the oil sector in Mexico.
If a UK parent company intends to send their own staff to work abroad, there may also be complications with immigration. It may be difficult to obtain a work visa, or visas may only provide for short stays; often there are limits on what business activities can be undertaken.
Other compliance requirements could also pose difficulties. There are often very complex rules related to hiring staff, managing payroll, complying with tax requirements, and declaring the activities of your business.
PEOs & PayrollPEOs, or Professional Employer Organisations, handle all the human resources and administrative work that comes with managing employees in different countries. They have the necessary legal structure in place to deal with employment, payroll, and immigration matters – as well as the expertise to ensure full compliance with foreign laws and regulations.
A PEO can be employed to help your UK company manage its subsidiary/subsidiaries abroad. Where the UK parent company lacks the expertise or infrastructure to hire and manage employees overseas, a PEO acts as an ‘employer’ of the parent company’s international workforce.
Most PEOs are large firms, able to tap into a whole range of benefits for your employees that wouldn’t otherwise be available. Some examples of common employee benefits that are available where PEOs are involved include medical and dental care, retirement plans, competitive pension schemes, short-term and long-term disability insurance, and educational programmes.
If the parent company is managing payroll itself, it must be registered as an employer in the jurisdiction of the subsidiary. Up-to-date information will need to be stored about each employee, including name, address, eligibility to work, payment details, tax codes and benefit status. Storage of such information must comply with local data protection legislation.
As an employer, the onus is on the UK parent company to update local tax authorities with information on all payments made in their jurisdiction. This allows them to keep track of their resident employees, and to ensure the correct deductions are made from any earnings.
Intercompany Transfers: Supporting Your SubsidiaryIn their early days, subsidiaries generally require some support from the parent company – transferral of assets and inventories, start-up loans, etcetera. The rules around these transfers, however, are very strict.
Because of the protocols set up to ensure that subsidiaries are autonomous and self-serving, any interactions between parent and daughter companies must be mutually beneficial. Ultimately, auditors will want to see that UK-based parent companies are not exploiting the resources of subsidiaries.
A transfer from the parent company to the subsidiary is known as a ‘downstream’ transfer and should only be transparent or visible to the parent company and its stakeholders. The parent company must record the transaction and applicable profit or loss.
Due diligence is hugely important at the time of the transfer, as any errors will result in a complex reconciliation process:
Make sure monetary values are recorded throughout the transaction with equivalent foreign currency figures. If the money sent is registered in one currency and the money received in another, fluctuating exchange rates may alter the value of the transfer.
Reports of monies sent and received must be submitted as they happen to ensure consistency. If a delay in reporting results in inconsistent journal entries for the parent and daughter company, an imbalance will occur.
Consider the tax implications of the transfer. Will VAT be charged on intercompany transfers, and who will pay it? Intercompany transactions must not interfere with the taxable income and liability of the group as a whole.
To make the process of intercompany transfers easier, it’s recommended that companies with subsidiaries invest in a financial consolidation and reporting package. Appropriate software should include an automated reconciliation tool with exception reporting, as well as a formalized escalation process to alert appropriate management about problems.
Finally, it’s worth considering foreign currency exchange providers for the transfer of funds from one currency to another. Providers such as Currencies Direct can save your business money by eliminating expensive transfer costs imposed by banks.
By discussing your unique business needs with a Sales Advisor, you’ll be given access to a host of tools to minimise revenue loss – including spot contracts, forward contracts and limit orders. These allow you to target the rate you want, avoiding unexpected losses from any volatility in the currency market.
Negotiating Subsidiaries: A SummaryTo summarise – setting up or acquiring a subsidiary is a big decision that requires careful consideration. Subsidiaries offer great opportunities for expansion, but demand initial investment to become truly profitable.
There are regulations for subsidiaries outside of the UK that monitor or prohibit foreign ownership, meaning it may be worth sharing assets and responsibilities with an existing foreign company. Experts already operating abroad can also advise on compliance.
Services and software also exist to help you navigate legal issues and payroll – alongside other necessary procedures involving data handling and reporting. It’s worth checking out how these providers can help your business.
Keep in mind the reason for your setting up a subsidiary in the first place – make use of local technology and manufacturing services while keeping abreast of relevant regulations. If the subsidiary fails to turn a profit, selling it on is a valid option.
Currencies Direct is one of Europe's leading non-bank providers of currency exchange and international payment services. Since we were formed in 1996, we've maintained our focus on providing innovative foreign exchange and international currency transfer services to corporations of all sizes, online sellers and private individuals. We have also expanded our services to provide dynamic and pioneering "business to business" solutions to help companies, tier 2/3 banks and other non-bank financial institutions to process their international payments. Our headquarters are in the City of London (United Kingdom) and we have operations in continental Europe, Africa, Asia, and the United States. Currencies Direct is jointly owned by private equity firms Palamon Capital Partners and Corsair Capital.