US Branch or Subsidiary: Liability and Taxes

When a European company sets foot in the US, one fundamental question comes up early: should the company itself do business in the US through a branch? Or should it form its own US company, a subsidiary? Both routes get you into the market. But they differ in who is liable, who files with the IRS, how profits are taxed twice and what the state requires.

This guide compares both routes under the Internal Revenue Code, US tax treaties and, as an example, Texas company law. The wider tax picture of your expansion, from corporate tax to payroll, is covered in the guide Tax aspects of your US expansion. Here we focus on one decision: branch or subsidiary.

1Two routes, one fundamental difference

A branch is not a separate person. It is an office, a warehouse or a plant of the parent company in another location. US law sees it the same way: in the examples to 31 CFR 800,224, a foreign company together with its branch is a single foreign person, and US immigration rules in 8 CFR 214.2(l) define a branch as a division or office of the same organization in a different location. So contracts in the US are signed by your parent company, US employees are hired by your parent company, and US lawsuits are filed against your parent company.

A subsidiary, by contrast, is a company in its own right under the law of a state, usually a corporation or an LLC. It has its own tax number, signs its own contracts and runs its own accounts. The parent is its shareholder. Deliveries, licenses, loans and services flow between the two and must be priced as they would be between unrelated parties.

For most European companies, the subsidiary is the usual route. A branch has its place for short projects, for companies whose industry makes a separate entity difficult, and where the parent is directly liable anyway. Make the decision based on the sections below, not on which one gets registered faster.

2Liability: who answers for contracts, employees and products

With a branch, your company is liable with all its assets, because it is the contracting party. A lawsuit in Texas or California is a lawsuit against your company back home. A judgment against the branch is a judgment against the parent.

A subsidiary generally shields the parent. Texas company law, for example, provides in § 21,223 of the Business Organizations Code that shareholders and their affiliates are generally not liable for the corporation's obligations, apart from the duty to pay for their shares. For the LLC, § 101,114 does the same for members and managers. Other states have comparable rules.

The shield has limits you need to know. If you manufacture a product or import it into the US, you are liable as the manufacturer yourself, even if a subsidiary handles the sales. Under 15 U.S.C. 2052, US consumer product safety law treats the importer as the manufacturer, and Texas product liability law in § 82,002 of the Civil Practice and Remedies Code requires the manufacturer to indemnify the seller against losses from product liability claims. Guarantees and comfort letters from the parent for leases, loans or supply contracts also break the separation. More in the guide Product liability and product approval in the USA.

3Federal tax: 21 percent, then a second layer

At first glance, both pay the same. A US corporation pays federal corporate income tax of 21 percent on its taxable income under 26 U.S.C. 11(b). A foreign company doing business in the US pays the same rate under 26 U.S.C. 882 on income effectively connected with that US business, known as effectively connected income.

The difference lies in the second layer. The subsidiary distributes profits to the parent as dividends, and under 26 U.S.C. 1442 it generally withholds 30 percent tax on them. A branch distributes nothing, so to keep it from coming out ahead, 26 U.S.C. 884 imposes the branch profits tax of 30 percent on the so-called dividend equivalent amount, essentially the part of US profit that is not kept reinvested in the US. In other words, the branch profits tax is the branch's dividend tax.

Tax treaties reduce both taxes. The IRS obligations differ too. The subsidiary files Form 1120 and, as a company at least 25 percent owned by a foreign person, files Form 5472 under 26 U.S.C. 6038A on its transactions with related parties. A foreign company with a branch files Form 1120-F, which according to the IRS instructions is due, for a company with a US office, by the 15th day of the fourth month after the end of the tax year, and it is subject to the same reporting duties under 26 U.S.C. 6038C. For missing information under 6038A, the law sets a penalty of $25,000 per year. More in the guide to Form 5472.

5When a permanent establishment arises at all

Under Article 7 of the tax treaties, the US may only levy federal tax on a foreign company's profits if it has a permanent establishment in the US, and only on the profit attributable to that permanent establishment. Article 5 of the treaties defines a permanent establishment along the same lines: a fixed place of business through which the company carries on all or part of its business, in particular a place of management, a branch, an office, a factory or a workshop. A building site or installation project only becomes a permanent establishment once it lasts more than twelve months.

Facilities used only for storing, displaying or delivering the company's own goods, only for purchasing or gathering information, or otherwise only for preparatory or auxiliary activities are excluded. Conversely, an agent in the US creates a permanent establishment if he habitually concludes contracts in the company's name, unless he is an independent agent acting in the ordinary course of his business. That is why an employed sales director with authority to sign contracts changes the numbers compared with an independent sales agent; more on this in the guide Selling in the USA.

6The home country side

How your home country grants relief on US profits under its treaty and its domestic law is something your accountant at home should clarify, ideally together with the US side, before the first invoice goes out in the US. Our tax concept describes how that coordination works, and the guide on the holding company explains why a holding in between can make sense.

7The LLC special case: legally a subsidiary, a branch for tax

Many groups consider an LLC because it is simpler to run. Under company law, an LLC is a genuine subsidiary with liability protection. For US tax, though, the basic rule in 26 CFR 301.7701-3 applies: a domestic single-member LLC that makes no election is treated as part of its owner, a disregarded entity. If your company at home owns it, the IRS sees that company itself doing business in the US. Form 1120-F, the branch profits tax and the permanent establishment rules follow, exactly as with a branch.

If you don't want that, the LLC can elect to be taxed as a corporation; it is then treated like a subsidiary corporation for federal tax. Whether that makes sense also depends on how your home country's tax law classifies the LLC, and the answers can differ from country to country. If you want a clear-cut solution from day one, set up the subsidiary as a corporation; the comparison of US entity types explains the differences.

For visas for the employees you send to the US, both routes work, by the way. The L-1 visa regulation in 8 CFR 214.2(l) expressly names both a branch and a subsidiary as possible US employers. What to watch out for when sending staff is covered in the guide Sending employees to the USA.

8State registration

Regardless of tax, every state requires companies doing business there to register with it. Texas covers this in Chapter 9 of the Business Organizations Code. Under § 9,001, every foreign limited liability company doing business in Texas must register; the law expressly names the foreign public or private limited company, so your company at home too. Foreign here means any company not formed under Texas law, including a Delaware corporation.

For a corporation, this is done with Form 301 at the Secretary of State, and the fee is $750; late registration may incur penalties. A company that fails to register cannot, under § 9,051, bring claims arising from its Texas business before Texas courts until it registers. § 9,251 lists what does not yet count as doing business, including a bank account, transactions in interstate commerce and a single transaction completed within 30 days that is not repeated.

For a branch, this means your company at home registers itself in every state where it does business, submitting its home registry documents. The subsidiary is formed in one state and registers in every other state where it does business. The guide Foreign Qualification explains how this works in other states, and the guide Which US state is best helps you pick the right home state.

9Making the decision

In the end, the choice comes down to a few questions:

• How high is the liability risk of the US business, for example from products, employees or long-term contracts, and should it stay separate from the parent?
• Will the US profits be reinvested in the US or distributed, and does your group meet the conditions for a reduced rate under your home country's treaty?
• How does your home country's tax law treat a branch, a corporation and an LLC?
• Does the US business need its own accounts, its own contracts and its own credit standing in the US?
• In which states will you do business, and where do you need to register?
• Will employees be sent over on visas, and who is their US employer?

For most European companies, these questions lead to a subsidiary corporation; for short projects and certain industries, to a branch. The overview Expanding successfully into the USA sets out the wider framework of your market entry, and the guide Taxation of the US corporation covers corporate taxation in detail.

In short

• A branch is legally the parent company itself, which is liable for its obligations. A subsidiary is generally liable on its own, but the parent can still be liable itself, for example as the manufacturer of a product.
• Under Article 5 of the treaties, a permanent establishment arises from a fixed place of business or a dependent agent with authority to sign contracts; pure storage, delivery and auxiliary activities do not count.
• A single-member LLC owned by your company is treated for tax as part of that company, so like a branch, unless it elects corporate taxation.
• Doing business in a state means registering there; in Texas, for example, a foreign corporation pays a fee of $750.

How we help you

• Form a CorporationThe US corporation (Inc) for growth, investors and your visa.
• Tax structureA clean structure between parent company and US subsidiary, or between you and your US company, coordinated with your accountant.
• US market entrySubsidiary, staff, taxes: your start in the US market.
• Corporation tax returnForm 1120 and Form 5472 for your US corporation.
• Withholding taxW-8 forms, withholding and treaty benefits, done right.
• Company formation consultationEntity type, state and tax consequences, before you commit.