what we think

By Chen Yun

When foreign-invested companies, particularly in the retail sector, seek to expand across different regions within China, they encounter a crucial need to establish a legal presence there to conduct business activities. To meet regulatory requirements, companies will often need to establish either a branch or a subsidiary—two commonly utilized structures for expansion. Each structure carries distinct legal, financial, and operational implications. Choosing the appropriate model is essential for regulatory compliance, liability management, and operational efficiency. Below is a comparative analysis of the key differences between branches and subsidiaries, intended to guide foreign companies in making strategic decisions aligned with their specific business goals.

Legal Entity Status

• Branch: Under the PRC Company Law, a branch does not have independent legal person status and, as such, is not considered a separate legal entity from the company that establishes it (parent company). It is restricted to conducting the same business operations as the parent company, or it may choose to operate within a narrower scope of activities permitted under the parent company’s business license. This limitation prevents the branch from expanding its business scope beyond what the parent company is authorized to undertake. Additionally, in cases of mergers or acquisitions (M&A), branches cannot be sold separately due to their lack of independent legal person status.

• Subsidiary: A subsidiary, in contrast, enjoys the status of a legal person, and is a separate legal entity distinct from its parent company. This autonomy allows the subsidiary to decide its business scope based on market demands. Additionally, in an M&A transaction, the equity of a subsidiary can be transferred to a third party, offering greater flexibility for corporate restructuring.

Legal Liability

• Branch: Under the PRC Company Law, the parent company assumes full civil liability for the debts and obligations of its branch. Since the branch is not a separate legal entity, any financial or legal liabilities incurred directly impact the parent company, increasing its exposure to risks.

• Subsidiary: A subsidiary bears its own liabilities, protecting the parent company from direct exposure to the subsidiary’s relevant risks. The parent company's liability is typically limited to its capital contribution to the subsidiary. This structure provides better legal and financial protection to the parent company, mitigating risks associated with the subsidiary's operations.

Taxation

• Branch: For branches operating across different regions in China, value-added tax (VAT) is paid locally, while corporate income tax (CIT) is typically consolidated with the parent company’s filings. Individual Income Tax (IIT) is withheld by the entity paying salaries, either the branch or the parent company. Branches, except in special cases, generally do not qualify for small and micro-enterprise tax incentives, and the financial support from local governments is often more limited compared to subsidiaries. Transactions between the parent company and its branches are not subject to taxation.

• Subsidiary: A subsidiary is taxed independently in its local jurisdiction, with CIT, VAT, and IIT filed separately from the parent company. Transactions between the parent company and its subsidiary must follow the arm’s length principle, and subsidiaries can benefit from local tax incentives.

Capital Requirements

• Branch: Establishing a branch does not require registered capital, making it a simpler option. This allows for easier setup and lower initial financial commitments.

• Subsidiary: A subsidiary requires registered capital, to be contributed in line with its Articles of Association. The capital commitment, while more demanding, provides the subsidiary with financial independence.

Establishment Procedure

• Branch: The process for establishing a branch is relatively straightforward, requiring fewer documents compared to a subsidiary. Unlike subsidiaries, branches do not have a complete corporate governance structure, such as a board of directors, and are not required to adopt Articles of Association. Instead, the parent company must appoint a branch principal to oversee the branch’s operations.

• Subsidiary: Setting up a subsidiary is more complex and involves a range of legal documents, including the Articles of Association. A full corporate governance structure must be in place, including the appointment of key executives such as a board of directors (or an executive director), a general manager, and a legal representative. Once established, a subsidiary can independently open branches under its own structure.

Practical Legal Considerations

In practice, the decision between establishing a branch or a subsidiary depends on the company’s long-term operational goals and its expansion plans.

• Branch: Branches may be suitable for companies prioritizing operational efficiency, as they can offer a streamlined structure with lower setup costs. This efficiency can support a range of expansion scales, whether you have ten branches, one hundred or even more, without necessarily complicating operations. However, branches do not provide legal separation for liability purposes, as liabilities are not shielded from the parent entity. For companies where liability exposure is not a significant concern, branches may serve as a practical choice, especially if a priority is to optimize operational efficiency over legal independence.

• Subsidiary: Subsidiaries may be the preferred option for companies needing greater legal separation and autonomy, or those aiming to establish relationships with local governments at sales level. Setting up a subsidiary can align with strategic objectives to build better connections with local government and the subsidiary may qualify for financial support offered by local governments. To shield the China headquarters from joint and several liability, the PRC Company Law does require a single-shareholder company to ensure that the subsidiary's assets are independent from the parent company’s assets. Companies are therefore advised to adopt independent financial systems, make sure that inter-company transactions adhere to the arm’s length principle, and prepare financial reports in accordance with the applicable accounting standards. Annual audits are also recommended to ensure full compliance.

Conclusion

Foreign-invested companies contemplating expansion within China must carefully weigh the pros and cons of establishing a branch versus a subsidiary. While branches offer operational efficiency and cost savings, they may expose the parent company to higher risks. Subsidiaries, though more complex to establish and requiring greater capital commitments, provide legal separation, potentially greater financial support from the local authorities, and greater autonomy in business operations. The decision is advised to align with the company’s long-term strategic goals and specific market needs.

R&P’s corporate/M&A teams support clients across a broad range of industrial sectors with expansion in China. For more information or specific inquiries regarding the establishment or operation of branches or subsidiaries, please contact [email protected] or your trusted contact at R&P.