Foreign companies seeking to develop their business in Lithuania very often have to decide on the most convenient legal form for their business. A subsidiary of a private limited liability company or a branch are two most common and efficient options. Before starting a business in Lithuania, it is essential to consider the key differences between a company and a branch and their legal and tax treatment, because this can significantly impact on their business in the future.
A company or a branch? Differences in formation, management and liability
It is essential for foreign companies thinking of starting a company or a branch to weigh the differences between the two legal forms. One relevant aspect is the establishment procedure, its complexity and duration. In both cases, the establishment procedure is quite similar. In either case the founder is required to submit the relevant founder’s documents, prepare and execute the documents of incorporation, have them notarised and registered with the companies’ register.
For a branch, the list of documents required from the founder is more extensive compared to a company (added to an extract from a foreign companies’ register and other documents of incorporation, there is a statutory requirement to submit copies of annual financial statements). Likewise, in the case of a branch, the authorised capital is not formed, so there is no requirement to deposit the amount of the authorised capital in the cumulative account. The requirement to form the authorised capital (the minimum amount of EUR 2500) and to open a cumulative account applies in the case of establishment of a company. Due to more stringent legal requirements, it can take more time to open a cumulative account for a founder who is a foreign entity, because the bank will need to complete special procedures to identify the beneficial owner of the foreign company.
Another relevant point for each founder to consider in choosing a legal form is management issues. In a branch, responsibility for its management rests with the head of the branch – general manager, whose status is equated to that of the company’s management body. Although under Lithuanian law a branch is not prohibited from appointing another management body – the management board, the procedure for the election of the management board or its powers are not governed by law. For this reason, it is advisable not to form the management board of a branch, because doing so can lead to difficulty in the conduct of the company’s own business. For instance, having the management board both in the company and its branch may lead to competition issues. Accordingly, in terms of management, a subsidiary is a more attractive option due to a broader structure and powers of the management bodies.
The key difference between a branch and a subsidiary lies in liability. From this perspective, a subsidiary is considered to be a more favourable legal form, because a subsidiary is a legal person with limited liability and is liable only to the extent of its assets, and only in highly exceptional cases enforcement may be levied against the shareholders/founders of the company. Meanwhile, the choice to establish a branch may be a risky one – if a branch has certain debts or outstanding liabilities, the person having the right of claim (creditor) would be entitled to enforce only against the assets of the branch or only against the assets of its founder (company), or firstly against the assets of the branch and if the claims cannot be satisfied in full, then against the assets of the founder, and vice versa. Enforcement against the assets of the branch and the founder can take place simultaneously. Thus, in the situation of a branch, the founding foreign company may be exposed to liability if the branch has debts.
Differences between tax treatment of a company and a branch
Apart from differences in legal liability, the legal form of a business also brings different tax implications. It is therefore necessary to consider the administrative burdens, prospective benefits, liability to pay value added tax (VAT), corporate income tax, and other obligations that each legal form entails.
Firstly, it is important to note that in the case of formation of a branch, both the branch and the founding company are required to register for tax purposes in Lithuania. Besides, the parent company is required to obtain a VAT identification number in Lithuania.
If a company is incorporated, it is automatically included in the Lithuanian Register of Taxpayers, and it becomes liable to register as a VAT payer only when its operating revenue generated (or anticipated) over the past 12 months is in excess of EUR 45 000, or if over the past calendar year the company acquired, or during the current calendar year anticipates to acquire goods from other Member States for an amount exceeding the threshold of EUR 14 000, also in other cases.
It is also noteworthy in the case of forming a subsidiary, if it itself arranges for the dispatch of goods to foreign countries, it may have to register for VAT and may be subject to VAT reporting obligations in foreign countries. In this respect, a branch would not incur additional obligations, because it is not a separate legal person and related obligations would be fulfilled on behalf of the company having established the branch.
One advantage of forming a company is that if the controlling company holds at least 10% of voting shares for a period of at least 12 months, dividends disbursed to the controlling company would not be subject to tax. Meanwhile, branches are not entitled to disburse dividends as they are not considered entities having their own separate legal existence.
In Lithuania, profit generated by a company is subject to corporate income tax at a rate of 15%, 5% or 0%. It should be noted that in Lithuania branches are deemed to be operating through a permanent establishment so that profit generated by branches is subject to corporate income tax at a rate of 15%. However, calculation of a taxable profit of a branch in Lithuania is not such an easy task to do, because there are many things to consider when determining revenue attributable to a branch: functions performed by the branch, risks assumed by it, the risk and capital ownership share.
A tax loss incurred by a company in Lithuania may be carried forward to the controlling company if certain conditions are met. Although the option of a tax loss carry-forward is not available for branches of Lithuanian entities under Lithuanian law, the founder can explore whether such option for a branch established in Lithuania is available under foreign tax laws.
Companies and branches are also subject to different accounting requirements. In Lithuania, companies are financially accountable entities and must therefore regularly file their financial statements with the manager of the registers of legal persons. Unlike companies, branches are not subject to such filing requirements. However, it is advisable for branches to keep their own accounting in order to simplify the recording of economic operations and events by the founding company.
To sum up, a subsidiary is recommended as a preferred form of business in Lithuania. The controlling company would be a separate legal entity with separate legal liability, enforcement against its assets would be greatly limited, also it would not be required to maintain separate accounts for the subsidiary, calculate corporate income tax payable in Lithuania. However, the best choice of legal form should be considered on a case-by-case basis.
The article is written by Martynas Bielskis and Giedrė Cesiulytė, Associates at COBALT.