What is a foreign subsidiary?

A foreign subsidiary is a company that operates in one country but is owned (either wholly or partially) by a company located in another country. For example, Google U.K. Limited, based in the United Kingdom, is a wholly owned subsidiary of California-based Alphabet. 

Foreign subsidiaries are separate legal entities from their parent company. They must obey the local laws and tax regulations, not those of the country where the parent company is based. 

Full legal separation is the primary difference between a foreign branch and a foreign subsidiary. A foreign branch is an extension of the parent company and operates under the same regulations as the parent company.

Why companies establish foreign subsidiaries 

A company may open a foreign subsidiary company for several reasons: 

• They want to establish a foothold in a new market and have the market research and data to support their presence there.
• They want to tap into the talent pool in a specific region. For example, many companies with foreign subsidiaries in India or Portugal established them to access the technology talent those countries offer. 
• They want to improve their tax position. 
• They hold physical assets in that country, such as factories or data centers. 

Foreign subsidiaries and employment law 

One advantage of a foreign subsidiary is that it operates independently of its parent company. They can conduct business operations per local law. 

Hiring talent is less complex for a foreign subsidiary than for a foreign branch. Opening a branch of your company overseas limits you to hiring local contractors (not employees) or bringing talent from the headquarter country, which is challenging from an immigration standpoint. A foreign subsidiary, in contrast, can hire employees according to company policies and local law.

Foreign subsidiaries offer parent companies protection against sanctions for violating international business or employment laws. The strict legal separation between the two ensures that the parent company maintains full immunity if the subsidiary commits a violation. 

Advantages of foreign subsidiaries 

Access to new markets

A foreign subsidiary allows your company to tap into a new market and grow your business exponentially. It also allows you to access a broader talent pool, which can help your company reach new goals. Local employees also know the local market and its opportunities (and challenges). They can help your company establish local relationships and tap into resources that might otherwise be unavailable. 

Local tax benefits

The tax implications can be advantageous since the foreign subsidiary only pays local taxes, which may be lower than taxes where the parent company is based. The parent company does not pay taxes on the subsidiary's earnings—they are only taxed on the dividends earned from the subsidiary, and only if they don’t invest those dividends back into the subsidiary. 

Reduced risk for the parent company

Establishing a foreign subsidiary helps a parent company eliminate certain risks since only the subsidiary company will be liable for tax, employment law, and other violations. 

Disadvantages of foreign subsidiaries

Costs

Establishing foreign subsidiaries is a costly endeavor. In addition to the substantial investments in research and planning, the expenses associated with establishing the company add up quickly. The fees to establish the entity can reach tens of thousands of dollars even before adding any staff. It’s also common for new foreign subsidiaries to dominate resources that would otherwise be dedicated to business growth, thus slowing profits.

Complexity

Although some companies welcome foreign companies with open arms, offering streamlined processes, tax incentives, and more, opening a foreign subsidiary is not always a simple task. Navigating international rules, hiring staff, and even locating real estate can be challenging without in-depth knowledge of the country and its norms. 

Some countries also have strict laws regarding ownership. For example, the UAE requires foreign subsidiaries to have a local partner with majority (51%) ownership. 

Cultural differences

Working with cross-cultural teams always creates the potential for challenges. Opening a foreign subsidiary requires finding ways to work around issues like time differences, varying work schedules, cultural differences in work habits, and different communication styles. 

Compliance challenges

Every country has its own set of laws regarding taxes, employment, and business operations. Unless the subsidiary’s leadership team understands those regulations, the company is at risk of non-compliance, which can result in significant penalties. 

Challenging to dissolve

If the subsidiary closes, the process can be significantly more challenging than dissolving an entity in one’s own country. Foreign subsidiaries must address the typical steps in dissolving a company, such as providing workers with notice and closing accounts, but individual countries may require additional steps. Despite not being responsible for dissolving the company, the parent company must provide legal assistance for the subsidiary to take care of those tasks. 

Alternatives to foreign subsidiaries 

The expense and complexity of establishing foreign subsidiaries lead many companies to seek alternatives. One common option is using a global employment platform.

A global employment platform, like Oyster, is a more streamlined and less risky option for many companies. Oyster lets you access the benefits of establishing an entity in the country without the hassles and paperwork. Oyster takes care of onboarding, payroll, benefits, and compliance with tax and labor laws, so you can focus on other responsibilities and business priorities.