Business is getting more global, and with the rise of remote work, professional and knowledge industries in particular often find themselves working across multiple geographies - and if you’re a remote-first company like Pento, you may have colleagues spread all over the globe.
Expanding your business across borders can be a smart move. It can open up new markets, provide access to talent pools and take advantage of favourable tax or regulatory environments. However, one key decision keeps cropping up: Should I incorporate a new corporate entity in this new market?
After all, there are other options: using contractors, setting up foreign branches, or using global Employer of Record (EOR) companies to hire locally.
In this article, we will discuss the pros and cons of incorporating a legal entity in a new country.
The considerations you need to take into account broadly group into these five areas:
When expanding your business into a new geography, it's important to understand the local laws and regulations. One key consideration is the concept of a Permanent Establishment (PE). A PE is a fixed place of business in a foreign country that is deemed to have a taxable presence there. Depending on the local regulations, having a PE may trigger various tax obligations and reporting requirements - if you are in a situation where you would have PE, you will probably incur the regulatory burdens of a local entity, so this is often a good trigger to establish an entity (and to at least reap the benefits too!)
Whilst you need to check the local laws, a common trigger is having senior executives based there, or salespeople able to negotiate and close deals from that geography. So if you’re setting up a UK sales team, based in the UK, targeting UK customers, chances of incurring PE in the UK are comparatively higher.
Incorporating a new legal entity in the new country won’t get rid of your regulatory requirements, but it can help you avoid the downside risks associated with having a PE. This is because the new entity is considered a separate legal entity from the parent company, and therefore has its own tax and legal obligations, and so risk and liability is at least more contained, rather than being able to go directly after the assets of your parent company.
Incorporating a new entity in a new country can offer additional protection against legal and financial liabilities. This is because if the new entity is set up with a limited liability structure, it is considered a separate legal entity from the parent company, and therefore can shield the parent company from certain legal and financial risks. So if a company contracts with a subsidiary and decides to sue, the assets of the parent company are more shielded.
This is especially advantageous in particularly litigious jurisdictions, and some companies incorporate entities purely to shield particularly important assets and intellectual property, or if there may be the potential to sell off the subsidiary independently at some point in future. Incorporating a separate entity can make it easier for a business to sell shares, raise capital, and divest ownership down the line.
However, it's important to note that incorporating a new entity also comes with the cost of setting up a new insurance policy for the entity, and it's important to work with local advisors to understand the specific insurance requirements for the new entity.
Tax is a crucial consideration when deciding whether to incorporate a new entity. Every country has its own tax laws and rates, and understanding them is essential to making informed decisions about where to set up a new entity. In some cases, there may be tax incentives available for setting up a new entity, such as reduced corporate tax rates or tax holidays.
On the other hand, there may be additional tax liabilities associated with operating in a new geography. For example, some countries impose a withholding tax on certain types of payments made to foreign entities. Therefore, it's essential to work with local tax advisors to understand the tax implications of incorporating a new entity in a new country.
This is one of the trickiest areas to navigate, so it’s worth getting advice; but as noted in the Regulatory Compliance and Permanent Establishment section, it’s important to remember that not setting up an entity doesn’t automatically exempt you from having to consider the tax implications.
At the end of the day, the tax man almost always finds a way to get his cut!
Setting up a new entity in a new country can also signal a commitment to that market and help establish your brand presence. Having a local entity can help build trust with customers and partners, and demonstrate your commitment to compliance with local laws and regulations, and make certain discussions (such as transfer of data between entities) simpler if both sets of operations are in the same country.
This can also reduce commercial friction as the legal jurisdiction of the contract between you and your customers is then likely in the customers’ usual jurisdiction. This can be especially important for enterprise businesses, and businesses whose services have a strong geographically-specialised component, where the advantages of local knowledge, cultures, and languages can add value to your business.
However, setting up a new entity also requires compliance with local regulations for company registration, accounting, and reporting, which is not a one-time-only investment.
There are legal and administrative requirements that must be met, such as registering the new entity, setting up accounting and payroll systems, and complying with local tax laws and regulations and requires ongoing compliance with local laws and regulations.
However, there are legal constraints in some countries that penalise using contractors that are for-all-intents-and-purposes actually employees, and the cost of using contractors or EORs can add up fast if you use a lot of them as they tend to charge a premium, so there usually comes an inflection point where the sum of these premiums can instead go towards investing in a local presence. Additionally, if your business has a manufacturing element, there can be significant cost savings incorporating local entities and purchasing local materials rather than imports.
It’s worth adding up the cost premiums spent avoiding a local subsidiary, and especially if you have a material number of prospective workers in that geography, weighing up the comparative costs of local incorporation.
In conclusion, expanding your business into a new geography can provide significant opportunities for growth and access to new markets, talent, and regulatory environments, but is a complex undertaking. When deciding whether to incorporate a new entity in a new country, it's important to consider regulatory compliance and permanent establishment, tax, liability, insurance, brand presence, signalling, and the cost and effort versus the alternatives.
Looking to incorporate an entity in a new country but worried about forgetting something?
There may be some items on here that don’t apply to you, but here’s a list of common items you may want to consider: