Establishing a Subsidiary vs. Setting Up a Branch in Germany

Germany is an attractive location for foreign companies looking to expand their business activities in Europe. One of the key decisions companies need to make when entering the German market is whether to establish a subsidiary or set up a branch. Both structures offer specific advantages and disadvantages, and the best choice depends on various factors, including long-term business goals, tax and legal considerations, and operational needs. This comprehensive article explores the differences, advantages, and disadvantages, as well as the legal and tax aspects of establishing a subsidiary and setting up a branch in Germany.

1. Definitions and Fundamental Differences

Subsidiary

A subsidiary is a legally independent entity created by a parent company (the foreign entity). In Germany, a subsidiary can be established in various legal forms, with the Gesellschaft mit beschränkter Haftung (GmbH) being the most common choice.

Characteristics of a Subsidiary:

• Legal Independence: A subsidiary is an independent legal entity that operates separately from the parent company.
• Own Accounting: It maintains its own accounting records and must prepare its own financial statements.
• Separate Liability: The liability of the subsidiary is limited to its own assets.

Branch

A branch (also known as a branch office) is not a separate legal entity but an extension of the parent company. It is an organizational unit of the foreign company, which remains fully liable for all the branch's obligations.

Characteristics of a Branch:

• Legal Dependency: A branch is not a separate legal entity but part of the parent company.
• Accounting: The branch’s accounting is usually integrated into the parent company’s accounting but must comply with German regulations.
• Liability: The parent company is fully liable for all the obligations of the branch.

2. Establishing a Subsidiary

Establishment Procedure

Establishing a subsidiary in Germany involves several legal and administrative steps:

1. Choice of Legal Form: The most common legal form for subsidiaries is the GmbH. Alternatively, an Aktiengesellschaft (AG) or an Unternehmergesellschaft (UG) can be established.
2. Drafting the Articles of Association: The articles of association must be notarized.
3. Registration in the Commercial Register: The company must be registered with the local commercial register.
4. Capital Contribution: The minimum capital for a GmbH is 25,000 euros, half of which must be paid in initially.
5. Business Address and Managing Directors: The subsidiary needs a business address in Germany and one or more managing directors.
6. Tax Registration: The subsidiary must be registered with the tax office and obtain a tax number and, if applicable, a VAT identification number.

Advantages of a Subsidiary

1. Legal Independence: As an independent legal entity, the subsidiary can enter into contracts independently of the parent company and is only liable with its own assets.
2. Local Presence: A subsidiary signals a strong and long-term presence in the German market, enhancing trust among customers and business partners.
3. Flexibility: The subsidiary can develop and implement its own business strategies tailored to local market conditions.
4. Tax Benefits: Subsidiaries can benefit from various tax incentives and depreciation options in Germany.

Disadvantages of a Subsidiary

1. Establishment Costs: Setting up a subsidiary involves higher costs, including notary fees, registration fees, and legal fees.
2. Accounting and Reporting: Subsidiaries are subject to strict accounting and reporting obligations, resulting in additional administrative effort.
3. Administrative Costs: Running an independent legal entity requires its own administration, which can incur additional costs.

3. Setting Up a Branch

Establishment Procedure

Setting up a branch in Germany is less formalized than establishing a subsidiary but still requires certain steps:

1. Registration: The branch must be registered with the local Chamber of Commerce (IHK) and the commercial register.
2. Business Address and Branch Manager: The branch needs a business address in Germany and a branch manager.
3. Accounting: The branch’s accounting is usually integrated into the parent company’s accounting but must comply with German regulations.
4. Tax Registration: The branch must be registered with the tax office and obtain a tax number and, if applicable, a VAT identification number.

Advantages of a Branch

1. Simpler Establishment: Setting up a branch involves fewer formal steps and lower costs compared to establishing a subsidiary.
2. Lower Administrative Costs: Since the branch is not an independent legal entity, the ongoing administrative costs are usually lower.
3. Direct Control: The parent company retains full control over the branch’s operations, facilitating uniform company policies.
4. Tax Transparency: The branch’s profits and losses are directly included in the parent company’s tax return, simplifying tax administration.

Disadvantages of a Branch

1. Unlimited Liability: The parent company is fully liable for the branch’s obligations, posing a higher financial risk.
2. Lower Market Perception: A branch may be perceived by customers and business partners as less entrenched in the German market, potentially affecting trust.
3. Reduced Flexibility: The branch is more closely tied to the parent company’s directives, potentially hindering adaptation to local market conditions.
4. Accounting Obligations: Despite integration into the parent company’s accounting, the branch’s records must comply with German regulations, adding complexity.

4. Tax Aspects

Tax implications are a crucial factor in deciding between establishing a subsidiary and setting up a branch.

Subsidiary

A subsidiary in Germany is treated as a separate taxable entity. Key tax aspects include:

1. Corporate Income Tax: The subsidiary is subject to corporate income tax (Körperschaftsteuer) at a rate of 15% on its profits.
2. Trade Tax: Additionally, trade tax (Gewerbesteuer) is levied, varying by municipality (averaging about 14%).
3. Value Added Tax (VAT): The subsidiary is liable for VAT and must file regular VAT returns.
4. Transfer Pricing: Transactions between the subsidiary and the parent company must be conducted at arm’s length and documented to avoid tax adjustments.

Branch

A branch is taxed as a non-independent part of the parent company. Key tax aspects include:

1. Trade Tax: The branch is subject to trade tax, similar to a subsidiary.
2. Value Added Tax (VAT): The branch is also liable for VAT and must file VAT returns.
3. Transfer Pricing: Intra-company transactions must be conducted at arm’s length, especially for internal service charges.
4. Double Taxation: The branch’s profits are typically taxed in the parent company’s home country unless a double taxation agreement allocates or reduces the tax burden.

5. Legal Aspects

Legal requirements and implications are another crucial factor when choosing between a subsidiary and a branch.

Subsidiary

1. Corporate Law: A subsidiary is subject to German corporate law, including the GmbH Act (for GmbHs) or the Stock Corporation Act (for AGs).
2. Labor Law: The subsidiary must comply with German labor law, including regulations on employment contracts, dismissal protection, and co-determination.
3. Contract Law: As an independent legal entity, the subsidiary can enter into contracts independently and is legally responsible for fulfilling them.
4. Insolvency Law: In case of insolvency, the subsidiary is subject to German insolvency law.

Branch

1. Corporate Law: A branch is subject to the parent company’s home country law and specific German regulations for branches.
2. Labor Law: The branch must also comply with German labor law.
3. Contract Law: Contracts are concluded in the name of the parent company, which is therefore legally responsible.
4. Insolvency Law: In case of insolvency of the parent company, the branch’s assets can be affected.

6. Operational Aspects

Operational considerations also play a significant role in deciding between a subsidiary and a branch.

Subsidiary

1. Management: A subsidiary can have its own management team, which is locally based and handles daily operations.
2. Strategic Flexibility: The subsidiary can develop its own business strategies and quickly respond to local market conditions.
3. Employees: The subsidiary can hire its own employees and is responsible for their employment contracts.
4. Bank Accounts: The subsidiary can maintain its own bank accounts and secure financing independently.

Branch

1. Management: The management of the branch often coordinates with the parent company, which can slow down decision-making processes.
2. Strategic Alignment: The branch is more closely aligned with the parent company’s directives, which may hinder adaptation to local market conditions.
3. Employees: Employees of the branch are formally employed by the parent company.
4. Bank Accounts: The branch typically uses the parent company’s bank accounts.

7. Conclusion and Recommendations

The decision between establishing a subsidiary and setting up a branch in Germany depends on many factors, including legal, tax, and operational considerations, as well as the long-term business goals of the company.

Subsidiary

• Suitable for: Companies looking to establish a strong and independent presence in Germany and willing to invest in the setup and operation of an independent legal entity.
• Advantages: Legal and operational independence, separate liability, higher market acceptance.
• Disadvantages: Higher establishment costs, strict accounting and reporting requirements.

Branch

• Suitable for: Companies seeking a less costly and more flexibly controlled expansion into Germany.
• Advantages: Easier and less expensive setup, lower administrative costs, direct control by the parent company.
• Disadvantages: Unlimited liability of the parent company, lower market acceptance, limited flexibility.

To make an informed decision, a detailed analysis of your company’s specific needs and goals is advisable. Our law firm, specializing in corporate law, is ready to assist you in choosing the right structure for your expansion into Germany and to guide you through the entire setup process. Contact us to schedule a personalized consultation.