A Long Road Ahead: Difficulties in Establishing, Maintaining & Dissolving Foreign Entities.

In this week's feature, we will delve into the critical steps required to establish a foreign entity, providing a detailed roadmap of the necessary steps, timelines, and the vital resources or departments required for establishing the entity. Throughout the piece, we will intersperse the steps with insights, using a variety of countries as examples to enrich the context and provide greater clarity into what this means in practical terms.

As you can imagine from the subject title, this journey is not for the faint of heart, and there are many, many steps along the way that need to be completed diligently. Each step poses fresh and unique challenges that can't be glossed over, and we will do our best to shine a light on these.

[Quick Tip]: It's heavy going, so for those of you interested in learning about a better route to market, as opposed to the traditional 'going it alone' method we are exploring today, we outline a far more palatable and ultimately optimal approach in the Summary section.

The guide itself below will be broken up into 3 parts to cover the full lifecycle of a foreign entity:

Part I: Establishing The Entity

Part II: Maintaining The Entity

Part III: Dissolving The Entity

Establishing A Foreign Entity: Legacy Method

In medium-sized organisations, the responsibility of implementing a foreign entity often rests with the Legal, Finance, and HR departments.

Such a business decision is typically made during the annual or strategic planning sessions, but sometimes they can be made more opportunistically. The CEO and Executive Team might determine that a key strategy for revenue growth involves international expansion by establishing a foreign entity.

Once high-level assumptions are plugged into the P&L, Balance Sheet, and Cash Flow – the hard part of execution falls on Operations and HR, who need to be cognizant of the nuances of a myriad of locally applicable regulations that will significantly influence each phase of establishing the entity.

Needless to say, foreign entity establishment requires a hefty investment in time, resources, and capital. The research phase alone might take months, if not years, but let's assume that portion of the work is done for the purposes of the guide today.

Establishing a foreign entity will expose a business to compliance risks that may result in fines, legal challenges, and reputational damage, so it's important to get this process right. After all, the foreign entity, while partially or fully owned by the parent, must comply with local tax and employment laws.

For the sake of today's guide, we will focus on permanent establishment – that is, a business with a fixed presence in a host country, this subjects it to sales tax, VAT, and other taxes depending on the jurisdiction. Do bear in mind there are different options to choose from, such as a foreign branch (which is a mere extension of the parent company as opposed to a separate legal entity in its own right) or subsidiary, or foreign employer options available in certain regions including EMEA.

Part I: Establishing The Entity

Getting Started: Registration

The first step to think about is drafting the corporate documents, completing the necessary forms, and gathering the required signatures to authorize the foreign entity registration.

For example, in the UK, you can choose from Private Limited, Public Limited, or Limited Liability Partnerships – fill in the incorporation forms, either IN01 or LLIN01 (for LLP). In this instance, you will draft & submit a Memorandum and Articles of Association, which outlines your internal governance, then you will allocate ownership and shares. You can appoint one director for a Private company; this needs to be two Directors for a Public company.

Contrast this to another country, such as Argentina, where there are three choices of incorporation - Sociedad Anónima (S.A.) – not dissimilar from a Public company, or a Sociedad de Responsabilidad Limitada (S.R.L.), which is not dissimilar from a limited liability company. There is also the Sole Shareholder Corporation (S.A.U), which might draw comparisons to a Sole Trader in the United Kingdom.

Once you've chosen your unique name, you will define the corporate structure and allocate shares – however, at least 25% of capital must be paid upon incorporation!

This goes to show that between alternative jurisdictions, there are different tax profiles and obligations to fulfill. Bear in mind that after completing your corporate registration, you will need to register yourself as an employer and complete proper filings with the ministry of labour, the social security office, as well as acquire the necessary insurances and vendors for the provision of benefits such as pensions, workers' compensation, etc. (this is a natural part of the registration process to enable companies to run payroll and remain compliant in the future).

Getting Physical: Setting Up an Office & Local Representation

Most countries require a physical registered office address to establish an entity and receive a tax ID – this can take weeks, if not months. Depending on exchange rates, market demand, and the size of space a business needs; the average real estate or office space prices in a target market might be more expensive compared to the organisation's headquartered location.

In addition to leasing office space, companies need to provide technology such as phones, computers, software, and other materials employees require to run their foreign operations successfully.

Another requirement to establish an entity and receive a tax ID is hiring a resident director. This is important because the resident director is any local employee who acts as a legal representative for a company. This person signs paperwork for a business in the new market and represents the company in front of all local authorities when required.

Companies must factor in the salary for this person or the fees for hiring a third-party company to act as the resident director.

The requirements for individual Directors to possess specific qualifications, to obtain the necessary licenses, vary by industry. We will delve into this topic in greater detail later in the article.

More Difficult Than You Would Think: Obtaining A Bank Account

To disperse funds, obviously, the foreign entity will need a registered bank account (the work required to obtain this is often an overlooked part of the process). The application process varies between jurisdictions and is dependent on obtaining Tax Identification Numbers such as a CUIT in Argentina, which can take weeks, or a Business Number in say Canada, which can take days!

Laura Isaza, VP of Subsidiary Management and Corporate Governance at Velocity Global, advises on why the application process is so difficult:

“in many cases, the Know Your Customer (KYC) process is what makes opening a bank account difficult. This is where the Ultimate Beneficiary Owners of the company are identified, and background checks are carried out on each individual and corporation with control and ownership of the organisation”.

People do not realize that this process may take up to 24 months depending on the jurisdiction; this is because of signature requirements, notarization, and apostille, as well as the process to identify those owners if you still don’t have clarity about that.

Take for example obtaining a Bank Account in Nigeria; it can be very difficult because of a local requirement to obtain a Bank Verification Number for all individuals managing the entity and all identified ultimate beneficiary owners regardless of their place of residency.”

Sounds complex? That’s because it is. In colloquial terms, this means to obtain a Bank Account in Nigeria; it is a very convoluted process because you need to identify the ultimate beneficiary owners, provide all documentation duly notarized and apostilled, and secure the BVN for everyone that controls the organization and has access to the bank account.

Obtaining Licenses

Another often overlooked factor is applying for licenses; sometimes you may require a Bank Account as a prerequisite; other times you may not; it varies from license to license and in each jurisdiction. For example, if you’re an importer or exporter looking to trade in the EU, you’ll need an Economic Operations Registration and Identification Number (EORI) needed for cross-border trade, Customs Declarations will also be needed on any subsequent flow of goods. The complexity of licensing and permits can depend on the industry, Health and Safety comes into play on foodstuffs, chemicals, or various nuances involved in military goods. Post-Brexit, UK companies require an EORI number. Again, just bear in mind this can take from days to weeks.

Depending on your business, you could require several licenses; for other industries, consider:

These licenses range in scope; for example, a pharmaceutical company will need import and export licenses to demonstrate compliance with health and safety standards. Whereas a company trading in agricultural goods has its own set of specific licenses that must be adhered to. It’s very important here that you seek specialized legal guidance because this is a complex, niche area to consider.

Onboarding

Now you’re ready to start onboarding your employees, so it’s time to draft contracts and offer letters, but not so fast, first you’ll need to ensure they are compliant in the jurisdiction the employee will be working in. You’ll need to source local legal advice; the quickest possible turnaround will be a week, but it could take several.

To onboard an employee, you will need a complete set of documents that includes an employment contract, offer letter, employment handbook, and up-to-date set of policies that will govern the employment relationship – these documents must be tailored to each country. You will also need to understand the personal documentation needed from the employee to complete their registration as an employee before the local authorities. In some countries, it is mandatory to verify the right of work before the start of the employment relationship, and you must allocate enough time prior to this date to collect and review all necessary documentation from the employees.

Payroll

Once your employees have accepted their offers of employment and are contractually ready to start work, you’ll need to ensure payroll is in place. This means understanding local tax and labor laws, social security contributions, and any other in-country deductions. Individual employment status itself has payroll implications; on top of that, you’ll need to gather all the correct employee information, make sure taxes and deductions are calculated accurately, and fulfill any local reporting requirements. Suffice to say, all but the largest and most well-resourced companies would struggle with this in a timely manner, so you’ll need to engage with a local Payroll Bureau in-country. Setting up the payroll will take time, days, if not weeks – so factor this into your timeline!

Part II: Maintaining The Entity

Upkeep: Ongoing Legal, Financial & HR Compliance

Unfortunately, the job doesn’t finish once you’ve successfully completed your first pay-run. Now comes the hard part, maintaining the foreign entity.

You must proactively manage the entity from a business, accounting, reporting, tax, audit, HR, and licensing perspective (not to mention ensuring it is a commercial success with sufficient cash flow)!

Ongoing Legal Compliance

You’ll need to ensure your legal counsel proactively monitors:

• Employment Law.
• Local and National Legislation.
• Any changes to commercial regulations that could affect the business.
• Licensing – ensuring compliance but also that permits are up to date.

Regular Compliance Audits

• Conduct regular compliance audits to assess adherence to local laws. This ought to be scheduled at least once annually to review employment contracts, regulatory changes, and any legal obligations. Not to mention the need to appoint auditors that will be triggered by in-country requirements or revenue thresholds.

Update Policies and Procedures

• It’s important to ensure this knowledge is reflected in company policies and procedures updated to reflect changes in local laws. It may be that training is required so employees are aware of ongoing compliance-related matters.

If you do not have an international legal expert in-house, you’ll need to consult with local legal firms to get the relevant experience on the ground to help maintain your entity adequately.

Financial Compliance

Regular Financial Audits:

Conduct regular financial audits to ensure compliance with local accounting standards and regulations. You’ll certainly need to seek a local accountancy firm to officially audit and review financial statements and administer internal controls.

Tax Planning:

Again, if you don’t have international tax expertise within your organization already, work with local tax experts to develop tax-efficient strategies. Regularly review tax compliance, including filing requirements, deadlines, and any changes in tax laws.

Financial Reporting:

Establish standardized financial reporting practices across all entities. Ensure that financial reports comply with both international accounting standards and local reporting requirements.

HR Compliance:

Your HR Teams will need to be very active in managing and maintaining the foreign entity, think about incorporating the following:

Regular HR Audits:

Conduct regular HR audits alongside the work the Legal Department is doing to assess compliance with local labor laws. Review employment contracts, working hours, leave policies, and employee benefits.

Global HR Policies:

Develop and maintain global HR policies that align with local laws. Periodically review and update policies to reflect changes in employment regulations; this out to be done at least once a year minimum.

Employee Training:

Provide ongoing training for employees and HR staff regarding changes in HR regulations, policies, and procedures. Ensuring that employees are aware of their rights and responsibilities, this can dovetail into the Legal Training and requires cross-departmental collaboration.

It’s important for both HR and Legal departments to collaborate to ensure compliance is achieved from both ends.

Part III: Dissolving The Entity

Offboarding

In the event of contract termination, it’s important to follow local laws which can be entirely different from the parent company’s place of origin. For instance, ‘At Will Employment’ only exists in the US therefore it is important that you understand the local requirements and associated costs of terminating employment with or without cause in other jurisdictions – no other country recognizes this concept as the US does.

If the ongoing maintenance and management of the entity have been performed adequately enough – global and local policies will be in place to be adhered to, compliance with local regulations is crucial to avoid legal complications, it’s certainly advisable to engage with local legal counsel.

Provide Proper Documentation:

• Document the reasons for termination clearly and objectively. Ensure that the documentation includes any performance issues, policy violations, or other justifiable reasons for the decision. This is often a hurried and overlooked step but is worth tackling proactively to avoid issues further down the road such as lawsuits for wrongful termination which can trigger fines to the company and compensation to the affected employee.

And finally – don’t forget cultural differences – we’ve all seen the horror stories in recent years in terms of how employers handle employee termination (recent ‘Tech layoffs’ spring to mind), organizations should seek to carry out termination procedures professionally, comprehensively, and with due care.

Dissolution

Many people don’t realize this, but the closure of a foreign entity is not a straightforward process and can take 3 times as long to dissolve the entity as was taken to set it up in the first place. These are the steps you’ll need to follow:

· Legal Review

• Obtain Board and Shareholder Resolutions
• Wind Down Employee Matters
• Appoint a Liquidator (if required)
• Settle Debts and Obligations
• Tax Clearance and Filings
• File Dissolution Documents
• Public Notices (if required)
• Asset Distribution (as appropriate)
• Close Business Registrations and Licenses (including Bank Accounts)
• Retain Documents (for the legal timeline required)
• Stakeholder Notification
• Continued Communication

Laura summarizes:

“Making the decision to enter a new market requires the involvement of all areas of your business and thoughtful consideration in relation to your corporate strategy. While having a local legal presence may be helpful for companies with a strong footprint locally and very specific local requirements, there are other options to consider. It is of utmost importance that the decision is analyzed from all angles of the business, understanding the local nuances and the additional requirements that the company will need to adhere to.

Furthermore, if you embark on this end-to-end lifecycle journey of establishing a foreign entity, you must at a minimum ensure that you have at least one person from each department dedicated to understanding the local jurisdiction, the applicable regulations, and the cultural differences that will impact the business. Sourcing local partners with confirmed expertise will also make a difference to your operation; there are many ‘unknowns’ that naturally arise when entering a new market, and these partnerships will be crucial to the success of your business in the long term.”

Summary

In summary, setting up a foreign entity without the support of a dedicated service provider (EOR) involves a comprehensive, multifaceted approach that requires meticulous planning, coordination across various departments (Legal, Finance, HR, and Operations), and a deep understanding of the local regulations, tax laws, and cultural nuances of the target country. The reality is that taking the legacy approach above is beyond the resources available to most businesses in today's business climate.

From the initial steps of registration and setting up a physical presence, through the ongoing management of legal, financial, and HR compliance, to the eventual dissolution of the entity, each phase presents its own set of challenges and requirements. The end-to-end lifecycle demands a significant investment of time, resources, and capital, highlighting the importance of having dedicated personnel from each department who are committed to understanding and navigating the complexities of the local jurisdiction.

Moreover, establishing strong local partnerships can provide invaluable support and insights, helping to mitigate risks and enhance the long-term success of the operation. Ultimately, while daunting, the strategic expansion into new markets through the establishment of a foreign entity can offer opportunities for growth and diversification, provided that companies approach the process proactively, diligently, and with flexibility.

Companies undertaking the above approach must understand that it will be costly, time-consuming, and require the concerted efforts of many FTEs over months, if not years.

A Better Way - EOR

In contrast, a global Employer of Record allows companies to legally engage with employees across international borders without having to set up a local entity or risk violating local country or state employment laws. Think of a global EOR as your international HR team that understands the complex labor laws and payroll regulations of the different markets your workforce is located in. In the context of the above, taking an EOR approach mitigates the need for most of the steps discussed in the guide; the result is 90% faster market entry and a reduction in overheads of 60% along with a minimization of compliance issues.

For an excellent resource that dives into the EOR approach, take a look at the below webinar which sees Laura tackle many of the issues covered in the guide, head-on:

How to Hire Anywhere With an Employer of Record

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Pete Dixon & Laura Isaza

Velocity Global