Branch or Subsidiary?

Branch or Subsidiary?

A question frequently asked by multinational companies seeking to do business in the Caribbean is whether they should operate through a “branch” or, alternatively, whether they should operate via a locally incorporated “subsidiary company”.

Regrettably, and all too often, the advice provided is couched in the following terms:

Both structures are largely inter-changeable, but have two main distinguishing features: an incorporated entity has the benefit of limited liability (i.e. the ability to ring fence legal liability in T&T), but “branches” have the benefit of requiring less red-tape if and when the time to wind up operations arises (a potential benefit to multi-nationals with short to medium term business interests in the territory).

In the view of the author, such conclusions are superficial at best, and inaccurate at worst. Such conclusions merely scratches at the surface of matters to be considered – advice that adds real value must analyze the proposed business adventure against the myriad of legal and regulatory matters that are relevant to the idiosyncratic circumstances of that business.

Consistent with this view, we must emphasize at the outset that this note is not intended to be a substitute for legal advice, nor is it intended to constitute an exhaustive discussion of all the possible considerations that may be relevant to this question. Instead, the author raise some of the tax considerations that should be considered.

The relevance of residence

As a starting point, it is relevant to note that a branch is likely to be treated as a “non-resident company” and a locally incorporated subsidiary is more likely than not to be treated as a “resident company” for tax purposes. This classification is the first significant distinction between the two vehicles.

World Wide Income vs. Territorial Taxation

Generally, companies that are resident in a Caribbean Country are usually chargeable to tax on their worldwide income, whereas non-resident companies are only chargeable on income directly or indirectly accruing from within that territory.

Accordingly, a branch’s tax liability is territorially ring fenced.

World Wide Loss Utilization vs. Territorial Loss Utilization

A natural corollary of the being taxable on worldwide income is that a Head Office should be entitled to take into account expenses, where so ever they occur in the world. Double tax treaties and the foreign tax credit rules focus on cross-jurisdictional tax allocation where “profits” are made. They are often silent on the issue of cross-jurisdictional “loss” allocation. As such, DTT do not deal with the computation of chargeable profits at an entity level.

A legitimate question, therefore, is to what extent can a branch structure enable a head office to reduce its taxes simultaneously at home and abroad? The author notes that inadequate consideration is often given to this very important question in the Caribbean.

In no Caribbean territory is a local parent permitted to utilize the losses of its non-resident subsidiary company in order to reduce its corporation tax liability. However, may a locally incorporated parent company utilize the losses of its non-resident branches in order to reduce its corporation tax liabilities?

Deemed Branch Profits Tax

In some jurisdictions, branches are deemed to have remitted all of their profits to their head office in the form of a dividend and is made subject to withholding tax.

Country Branch Profit Tax
Antigua
Belize
Dominica
Grenada
Guyana
Jamaica
Montserrat
St. Lucia
St. Kitts
St. Vincent
Trinidad & Tobago

Companies, however, only pay withholding tax on actual dividend payments made. The withholding tax is applicable, at most, on the sum after Corporation tax is paid (i.e. profit after tax).

Withholding tax implications

As a matter of Statutory interpretation

The following Caribbean countries have specifically legislated that for the purposes of withholding tax applicability a branch and head office must be treated as separate legal personalities:

Country Separate person
Antigua
Belize
Dominica
Grenada
Guyana
Jamaica
Montserrat
St. Lucia
St. Kitts
St. Vincent
Trinidad & Tobago

However, in the absence of specific legislation then, and in accordance with the Caribbean’s common law tradition, regard must be had to the applicable case law.

The leading case in the region is the Privy Council case of  Appeal Commissioners v Bank of Nova Scotia [2013] UKPC 40 (download here). In this appeal, their Lordships were tasked with the construction of the Grenadian Income Tax Act (s. 50(1)) to determine whether a withholding tax obligation arose in respect of a reimbursement paid by a Grenadian Branch to its Canadian Head Office.

The material provision of the GITA provided as follows:

“50(1) Where a person whether or not engaged in a business in Grenada makes payments to a non-resident person of interest… discounts, commissions, fees, management charge, rent, lease premium, license charge, royalties or other payment whether or not the payer is entitled to deduct such payment in computing chargeable income of a business, the payer shall deduct tax at the rate specified in the third schedule and pay the amount of tax so deducted to the Comptroller within seven days after the date of payment or credit to the payee.”

The Grenadian Court of Appeal, with which the Privy Council later agreed, took the view that the legislation, though not using the term “other person” as in Antiguan legislation, does nonetheless imply a duality of entities. Further, the Privy Council opined that the word “person” is clear and does not admit the inclusion of the unincorporated Head Office and that “the payer and the payee being the same person, section 50 has no application.”

Is there a “payment”?

The obligation to remit withholding tax to the applicable taxing authority is triggered when there is a payment. Consequently, expense recognition in the context of cross-border transactions operates as an exception to generally accepted accrual accounting standard – it operates on a cash basis. Specifically, the obligation to remit withholding tax is only accounted for when the transaction has been consummated in a “payment”, and the expense is only recognized for tax deductibility purposes when WHT has been accounted for. 

Interestingly, it is universally recognized that interest is taxable or expensed on a cash basis, however as a matter of practice in the Caribbean there is inconsistency in the application of payment in the context of WHT applicability.

In the T&T case of Esso case (download here).

Are inter-company transactions tax deductible?

Related to the question of whether WHT is applicable on payments between a branch and its head office is whether an inter-office (branch/head office) transaction is relevant for tax purposes. By way of context, if a transaction were to occur between a branch and its head office both domiciled within a locality, the transaction would be a nullity for tax purposes. Should it make a difference to the taxability of the transaction that territorial waters are inter-posed in between?

It is important to consider at the outset that an external company / branch on business in a territory is a “resident” of another country. In the lexicon of double tax treaties, a branch is a “permanent establishment” of a company that is a resident of the other member country to the Double Tax Treaty. A permanent establishment “means a fixed place of business through which a resident of one of the Contracting States engages in industrial or commercial activity” (US/TT Double Tax Treaty Article 9(1)). As such, one must analyze the terms of the applicable Double Tax Treaty for additional source of guidance on the tax treatment.

It is common for the “Business Profits” Article of treaties based on the OECD Model to contain the following provisions (e.g. 7(2) and (3) of the US/TT DTT):

(2)  Where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

(3)  In determining the profits of a permanent establishment there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment , including an allocation of executive and general administrative expenses incurred for the purposes of the enterprise as a whole, whether in the State in which the permanent establishment is situated or elsewhere.

In other words, where there is a branch and head office relationship, the payments to the HO are tax deductible. The import of this section is that one can disregard the reality that the branch and head office are one and the same legal entity, but can treat them as separate entities for the purposes of profit allocation.

Needless to say, if inter-office payments are tax deductible, may not incur withholding tax and may not be subject to a management charge restriction, operating through a branch may be particularly beneficial to some multinationals vis-à-vis a subsidiary.

Interestingly, there is no similar clause to section 7(2) of the OECD model. Instead, the language of the Caricom Treaty is as follows at article 8(3) “

“3. In determining the profits from a business activity there shall be allowed as deductions expenses which are incurred for the purposes of that activity in accordance with the laws of the Member State in which such activity is undertaken”

In other words, whereas the OECD Model specifically addresses this issue and creates the legal fiction of independent enterprises – the Caricom Treaty does not. In light of this, can a Caricom enterprise treat an inter-company transaction as taxable if the domestic law is silent on the issue?

Conclusion

For multi-national companies seeking to do business in T&T, it may be worthwhile considering using a branch instead of a subsidiary. One basis is that on inter-office transactions there ought not to be withholding tax, whereas on transactions between Parent and Subsidiary WHT may be a consideration.

 

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