Expanding overseas can be a valuable step for a UK business, especially where there is demand from international customers or an opportunity to build a presence in a new market. However, the structure used to trade overseas needs careful thought from the outset.
The usual choice is between setting up an overseas branch or incorporating an overseas subsidiary. Although both options allow a UK business to operate abroad, they are very different for tax, legal liability, commercial risk and HMRC compliance.
(Reading Time: Approx. 6 minutes)
Topics Discussed:
- The difference between an overseas branch and an overseas subsidiary, including how profits and losses are treated.
- The key tax issues businesses should consider when expanding overseas, including transfer pricing, withholding tax and double tax relief.
Why the structure matters
When a UK company starts trading overseas, it should not choose a structure simply because it appears cheaper or easier at the beginning. The decision should be based on the country involved, the expected level of profit or loss, local tax rules, commercial risk, the use of intellectual property and the long-term plans for the business.
A branch is generally treated as an extension of the UK company. A subsidiary is a separate company in its own right. This distinction affects how profits are taxed, whether losses can be used in the UK, how overseas liabilities are managed, and how HMRC may review transactions between connected businesses.
Overseas Branches
What is an overseas branch?
An overseas branch is usually part of the UK company operating in another country. It may be an overseas office, a local sales operation, a warehouse or another fixed place of business. In tax terms, this may amount to a permanent establishment.
The important point is that the branch is not normally a separate legal entity. It is the UK company trading overseas. This can make the structure simpler to operate, particularly where the business is testing a new market or the overseas activity is limited.
Profits and losses
One of the main advantages of a branch is that its profits and losses are generally included within the UK company. This can be useful where the overseas operation is expected to make losses in the early stages.
Many businesses incur significant costs when expanding abroad. These may include professional fees, recruitment, travel, premises, marketing and local registrations. If those losses belong to the UK company, they may potentially be offset against UK trading profits, subject to the relevant tax rules.
This can provide a useful cash flow benefit during the set-up period. However, the overseas country may also tax the branch, meaning the UK company may need to consider double tax relief. There is also a UK foreign branch exemption regime which can, in some cases, exclude overseas branch profits from UK Corporation Tax. The difficulty is that where profits are excluded, losses may also be excluded. This needs to be reviewed before any election is made.
Commercial risk
The main disadvantage of a branch is the commercial risk. As the branch is usually part of the UK company, overseas liabilities may attach directly to the UK business.
This could include local tax enquiries, employment claims, contract disputes, customer claims, supplier issues or regulatory penalties. In some countries, these risks can be significant and difficult to predict. A branch may therefore be straightforward from an administrative perspective, but it may expose the UK company to overseas tax and commercial liabilities.
For that reason, a branch may be more suitable where expanding overseas is low risk, where losses are expected at the beginning, or where the business is testing a market before committing to a more permanent structure.
Overseas Subsidiaries
What is an overseas subsidiary?
An overseas subsidiary is a separate company incorporated in the overseas country. It may be owned by the UK parent company, but it has its own legal identity. It will usually enter contracts in its own name, file local accounts, pay local taxes and comply with local company law.
This separation is often the main reason for using a subsidiary. It can help protect the UK company from overseas trading risk, provided the structure is set up and operated properly.
Profits and losses
The profits of an overseas subsidiary do not automatically become the profits of the UK parent company. The subsidiary will normally be taxed in the overseas country under local rules. If profits are later paid to the UK company, this may be done through dividends, royalties, interest, management charges or other arrangements.
Losses are also usually retained in the overseas subsidiary. This means that if the subsidiary makes losses in the early years, those losses will not normally be available to offset against the UK company’s profits. This is a key difference when compared with a branch.
Costs and administration
A subsidiary is usually more expensive to establish and maintain. The business may need local company formation, local accounts, tax registrations, payroll compliance, legal advice, accounting support, a bank account and ongoing company filings.
These costs are not necessarily a reason to avoid using a subsidiary, but they should be understood before the structure is created. A subsidiary should be chosen because it is commercially and tax appropriate, not simply because it appears to be the standard route.
Intellectual property and withholding tax
A subsidiary may be useful where valuable intellectual property is involved, such as software, patents, copyright, trademarks, brand rights or technical know-how. For example, a UK company may licence intellectual property to an overseas subsidiary in return for a licence fee.
This can be commercially sensible, but the fee must be reasonable and properly documented. HMRC may consider whether the overseas company has real substance and whether the profit allocation reflects the actual activity being carried out.
Withholding tax should also be checked. Some countries deduct tax from dividends, interest, royalties or service payments before the money is paid to the UK. Double tax treaties may reduce this tax, but relief is not always automatic and claims or forms may be required.
Choosing the right option
There is no single correct answer. A branch may be appropriate where the overseas activity is limited, commercial risk is modest and early losses are expected. A subsidiary may be more suitable where the business wants legal separation, local contracts, overseas employees, intellectual property arrangements or a long-term international presence.
In some cases, expanding overseas may also sit within a holding company structure, particularly where there are several companies, valuable intellectual property, international investors or future sale plans. These structures can be effective, but they add further tax and compliance issues.
Summary
Expanding overseas can create valuable commercial opportunities, but the structure must be considered carefully before anything is put in place.
A branch may provide simplicity and possible access to early losses, but it can expose the UK company to overseas liabilities. A subsidiary may offer stronger separation and may be better for long-term international trading, but it brings additional costs, transfer pricing issues and local compliance obligations. Before setting up overseas, take professional advice so the structure is right from the outset.
If your business is considering an overseas branch, subsidiary or holding company structure, speak to us before acting. We can help you manage the tax risk, and choose the right commercial route.
Fill out our form here for any questions, email us at info@taxexpert.co.uk, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel
