UK businesses have a whole new landscape to navigate in terms of exporting to Europe after Brexit, and some are responding by already establishing a presence in the region. By 1 January 2021, some 500 businesses [1] – mostly UK-owned, or UK-based with overseas owners – were already making inquiries about setting up branches, depots or warehouses in the Netherlands alone for "Brexit-related reasons".
“Unsurprisingly, customs and supply chain is the biggest issue facing SMEs post Brexit, but legal and regulatory issues are coming up close behind,” says Sally Jones, Trade Strategy and Brexit Leader at EY. “Our clients are telling us that the average amount of time it takes to complete all of the formalities has increased from about 30 minutes per consignment to something more like seven hours.”
Costs of doing business in the EU are also increasing. Trading charges on goods, services, exports and imports add an average of 8-9% to business costs [2].
For practical advice on how to minimise the cost of Brexit to your business, listen to our Business Class Money Minutes podcast episode.
Jones says the real question businesses need to ask themselves is: “Do you have people who can spare the time you need to complete that paperwork and do they have the necessary knowledge to complete it correctly?”
Why set up an EU presence to support your business following Brexit?
Having a presence in the EU – whether by opening a branch or incorporating a subsidiary – can help SMEs mitigate the new customs rules that came into force on 1 January 2021.
When exporting goods from the UK to the EU, the branch or subsidiary can act as the consignee and declarant, thereby reducing the required paperwork and customs checks, and avoiding transportation delays.
What is the difference between a branch and a subsidiary?
A branch is simply an office that is based in a different location, which acts as an extension of the head office. It's not a separate legal entity, therefore the parent company owns the liability for the branch office. Its accounts are normally maintained jointly with the head office. While some local rules and regulations will apply to a branch office, it is predominantly governed by the laws and rules of the parent company.
A subsidiary is a company that belongs to a parent or holding company. It's a separate legal entity, so it is responsible for its liabilities and for maintaining its accounts. It operates wholly in the local market and is therefore subject to its laws and rules.
How do you decide whether your SME should set up an EU branch or subsidiary?
Why set up a branch?
A branch is a good option for an SME that needs to replicate one or more of its functions inside the EU but perhaps can’t afford – or doesn’t have – the growth plans to set up a subsidiary.
Pros of setting up a branch
- The parent company has a high level of control over a branch because it reports into head office, and it follows the same laws and rules.
- It does not require significant investment to establish a branch: its overheads can simply comprise of office space and staff.
- You can set up a branch initially, then incorporate it into a subsidiary if it’s successful.
Cons of setting up a branch
- A branch is limited by the activities of the parent company so it’s difficult to explore the EU market given the centralised management approach.
- The parent company is liable for the branch so if it incurs any debts or fines, it will fall to the parent company – and its shareholders.
Describing the investment to set up a subsidiary as "significant", Ian Macleod Distillers Ltd tells the Institute of Chartered Accountants in England and Wales (ICAEW) that it decided to set up a branch to ensure it would be compliant with new EU consumer regulations. Pre-Brexit, the distillery could use a single label with a UK address on its products across all EU markets as the UK was a member of the EU. Post-Brexit, that had to change, resulting in "a significant proliferation of labels, creating many additional SKUs (stock-keeping units) and thus a stock control headache. The benefits of scale will be lost when scores of labels have to be originated and printed," writes the ICAEW. Launching a branch allows the company to have "an enduring address for the back label and sales staff who will be additional to current market resource". [3]
Why set up a subsidiary?
A subsidiary is suitable for large, established SMEs with long-term expansion plans and, in some cases, the capital to do so.
Pros of setting up a subsidiary
- A subsidiary is autonomous so it's able to capitalise on new opportunities within the EU – it can form partnerships and diversify into different industries.
- As a separate legal entity, a subsidiary offers greater legal protection to the parent company and shareholders as they will have no liability for any of the subsidiary’s debts or fines.
- A subsidiary has strong credibility, which makes it easy to do business with service providers and banks within the EU.
Cons of setting up a subsidiary
- It's costly and time-consuming to set up a subsidiary because there is financial and legal due diligence that must be conducted. For example, a public company must secure at least 37,000 euros (£31,696) to set up a subsidiary in France [4].
- As a subsidiary operates wholly in the EU, it's vulnerable to the regulatory and political environment of the bloc.
CEO of Radically Digital, a London-based digital consultancy, Bobby Idogho, says he chose to open a subsidiary company in Portugal in 2021, partly in response to Brexit and partly due to the company’s “future desire to have the two companies eventually being able to operate independently as separate entities.” This decision has allowed the company to increase headcount by 18% and revenue by 11% per month.
“Our Portuguese office has allowed us to continue to quickly grow our headcount while attracting talented and diverse employees locally. We will have between seven to 10 employees in our Lisbon office by the end of September, and already have plans to explore other cities in Portugal,” he says.
Idogho says in hindsight the business should have carried out a more thorough cost-benefit analysis to understand the costs involved in setting up its subsidiary.
“Our research of surface costs, such as accountancy fees, legal fees and advertised salaries appeared very inviting but some unexpected costs arose, which included mandatory medical screenings for employees, insurance costs, two months’ extra salary payments a year (it’s standard in Portugal to offer 14 paychecks per year), payroll provider costs and a requirement to pay tax in Portugal for the founders until an A1 certificate [5] proving payment of UK tax is provided,” he says.
“If we were to repeat the process in another location we would initially engage individuals in that location on a contractor basis. This would allow us to test the labour market for around six months without committing to large upfront administration and setup fees.”
Time really is money when it comes to navigating post-Brexit rules and regulations, but sorting international payments when exporting to the EU does not need to add further complication to the day-to-day running of your business.
Sources
[2] Trade in services and Brexit briefing from House of Commons (pg. 54)
[3] ICAEW, Brexit planning: labels, logistics and whisky
[4] LawyersFrance.eu, Subsidiary vs. Branch in France - 2021 Procedure