Subsidiary vs. branch

  • 2007-12-05
  • by Mantas Petkevicius [Sorainen]
The first thing foreign companies should do when starting a business in  the Baltics is to choose the most appropriate business structure and its form of incorporation. Currently, the most popular vehicle for conducting business in Lithuania is a private company (subsidiary). A foreign enterprise may also opt to establish a branch or a representative office, or engage in cross-border activities. Lithuanian laws allow a representative office to engage in very limited non-commercial activities; it is, however, a sufficient vehicle for purposes of marketing, representation and promotional activity on behalf of the parent company, though not for true commercial activity. By contrast, a branch can accomplish the latter.

Either way, there are important tax regimes to consider for branches and Lithuanian companies when debating the proper form.
The registration of a branch in Lithuania would automatically lead to the presence of a permanent establishment, whose income is taxed under similar rules as a Lithuanian company. However, differences exist.
It is noteworthy that the main distinction lies not in a difference of the applicable rules but in a lack of clear regulation and practice of state tax authorities with respect to taxation of branches. For example, pursuant to existing laws, a branch may attribute costs of the foreign (principal) company on the basis of documentation supporting that those costs directly relate to the business activity of the branch. However, procedurally how this should be done and what support documentation is required are not sufficiently clear.
Further, there are certain differences with respect to debt financing of branch offices. Pursuant to Lithuanian laws, any interest-like or royalty-like payments from a branch to the foreign (principal) company will not be deductible by the branch for corporate income tax purposes. While the laws are silent on other agreements between the principal company and the branch, however, we consider that the state tax authorities may apply a narrow approach and also treat any payments made by the permanent establishment to the foreign company as non-deductible expenses.

In addition, in cases when the foreign company decides to transfer the business in Lithuania, the transfer conducted through a subsidiary will provide more flexibility comparing to the transfer of business operated through a branch.
Summing up, under the general rule the establishment of a branch in Lithuania does not provide additional benefits compared to the establishment of the subsidiary. The lack of clear regulation and the conduct of state tax authorities with respect to taxation of branches lead us to conclude that a Lithuanian company is still a more appropriate vehicle for conducting business.

Mantas Petkevicius is a senior associate at Sorainen in Vilnius