Company incorporation

Whether to set up a subsidiary will depend on many factors. Obviously, the main one is the reality of a market opportunity and an attractive project. But there are others that we would like to highlight and for which companies need tax legal advisory in a company start-up process in order to make the best decisions:

• Need to hire personnel in the destination country, although this could be solved by using our personnel outsourcing service, so that the company will have employees who are on our payroll.
• Requirement to be locally incorporated to execute the project (public tenders, local invoicing, etc.).
• Importance of having a local presence, showing proximity to the customer.
• Inability to be price competitive with local companies, especially for tax reasons.

The provision of services in the country may be carried out through a subsidiary (incorporation of a new company with its own legal personality) or through a branch or representative office (permanent establishment without its own legal personality). A branch is, for all purposes, a foreign company. On the other hand, a subsidiary is a local corporation (whether Mexican, Colombian, Chilean, etc.), even if it has foreign capital.

Even when the incorporation of companies is not formalized, a permanent establishment exists when there are facilities or workplaces of any kind in the territory, on a continuous or habitual basis, in which the activity or part of it is carried out, or when acting through a proxy agent to contract in the name and on behalf of the taxpayer. You will be informed of this as part of UR Global’s business consulting.

The first limitation, and possibly the most important one, is that a permanent establishment, because it lacks its own legal personality, does not allow the separation of responsibilities between the permanent establishment and its parent company, so that any commercial, tax or labor contingency will generate liabilities for the head office.

The second limitation, of a tax nature, relates to the fact that taxation (for example, in Mexico) of the subsidiary’s or branch’s profits (30% corporate income tax in Mexico) is higher than that which will be borne in Spain. This makes it advisable to use mechanisms to reduce taxation at source.

In this sense, the taxable base of the permanent establishment will always be greater than that of the subsidiary, since permanent establishments are taxed on the total income earned, and payments to the head office for royalties, commissions, technical assistance, transfer of assets, interest, return on equity capital, etc., are not deductible. In other words, branches can only deduct expenses effectively allocated to the activity of the branch.

Conversely, a subsidiary can deduct the services received from the parent company, thereby reducing its profit and thus its corporate income tax liability.

The most frequently performed parent-subsidiary operations are:

• Technical assistance (fee-based)
• Loans (interest bearing)
• Administrative management support services
• Merchandise trade

An analysis should be conducted on a case-by-case basis to determine if double taxation agreements between the permanent establishment and the parent company can be used to enhance tax optimization strategies when incorporating companies.

In addition, permanent establishments face additional limitations and problems when carrying out certain procedures with the tax authorities (obtaining an importers’ registry, opening bank accounts, etc.), due to the fact that they are non-resident entities.

Finally, if one plans on operating in third countries, it is important to remember that (in general) the branch cannot benefit from the double taxation agreements that the state where it resides has signed with such third countries.

• To be more competitive in price, since the distributor’s margin makes the product more expensive.
• To keep track of customers and ensure first-hand knowledge of the market.
• To have more financial muscle to advance the cost of the imported product and VAT, which is sometimes an impediment for the distributor to sell more, since it might risk financial distress.
• To prevent the distributor, having won customers’ trust, from switching to a competing company.