Everything you Need to Know about Legal Entity Rationalization

If you’re currently in a position where you are reviewing your business performance, especially if you are operating internationally, and you’re noticing unnecessary expenditures and drains on resources, then legal entity rationalization may be a profitable and effective solution for you moving forwards.

To give you further insight into this area of business management, we’ve put together the following blog that explains everything you need to know about legal entity rationalization.

What is legal entity rationalization?

Any time a company is removing entities from its current structure, or establishing whether it makes sense to have its current entities in the current form, the legal entity rationalization process begins.

In many instances, at the time of incorporating the business, having such entities may have been done for a reason, but things change, and it may not be the same approach and simply no longer fulfill their original purpose. For example, maybe the business operations or structures have changed, and the need for these entities is no longer required. Or perhaps entities that cost a lot but provide little value to the business.

A business may also look at its organization chart and decide it wants to remove entities from its structure.

Essentially, it is about reducing the number of entities or transforming the entities into different forms of operations.

What is legal entity management?

Legal entity management refers to maintaining and updating the business corporate records to keep track of the changes in the corporate structure and corporate governance. Anything that happens during the life of that corporation, such as a change of director or registered address, should be recorded and kept as part of their business records.

Any corporate changes, shareholder changes or any legal changes should also be recorded as part of entity management activities.

In order to be compliant, you also need to consider tax, statutory and regulatory obligations. For example, you could be compliant on filing your corporate annual filings, but if you’re missing the tax piece, you are not performing entity management properly.

Why would a business need legal entity rationalization?

There are many reasons why a business may want to begin the process of legal entity rationalization. For example, if the company was active in the merger and acquisition (M&A) space and took over these entities as part of the M&A strategy, they may realize after a while that they don’t need all the entities to be operational in a country.

A business may also realize that their operations are no longer performing in accordance with their initial target, making it clear they need to close down the operations or transform the way in which they work in the countries.

For example, instead of having a limited company, they may realize they just need a VAT registration or permanent establishment.

From a risk perspective, if the entities are no longer operating, there is no point in having them continue to run, as this is a drain on resources.

When a business starts operating with a business plan in place and it starts incorporating different countries and jurisdictions, it can be tough managing the obligations that are associated with this, and so legal entity rationalization may be the next best course of action.

What are the benefits of legal entity rationalization?

Legal entity rationalization offers many benefits, such as:

  • Reducing costs
  • Eliminating efficiencies
  • Improving business profitability
  • Reducing complexities
  • Improving visibility
  • Facilitating the consolidation of the numbers
  • Minimizing liability

While there is an initial cost involved with beginning the legal entity rationalization process, it will save you money in the long term.

For example, if your business is sitting on unneeded and unused entities, you will end up spending more money on keeping them running, and so taking the time to make the necessary changes to be where you should be will have a better financial impact.

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HSP’s legal entity rationalization checklist

Companies perform several activities as part of legal entity rationalization.

1. Understand the objective

Firstly, you should start with understanding what the objective is and what you want to achieve by going into this exercise. Consider the following:

  • Is it because you have more entities in one country and are trying to reduce this to just one to decrease the cost of compliance?
  • Is it because the operations have changed, and you don’t need a limited liability company or stock company anymore?
  • Is it because you are reconsidering the way in which you operate in certain countries? For example, maybe you no longer need to have an entity at all, because you can use an Employer of Record (EoR) in order to have people working for the business in different countries.

2. Define the end state

Once the purpose is clarified, you should define what the end state is and what the organization chart should look like at the end of the exercise.

For example, a business may have four entities and wants to reduce it to just two, or it has a limited liability company in a country and just wants to have a representative office.

3. Understand the liquidation process

From here, you should look to understand what the liquidation process is, as the process has different components.

From a legal component, you need to understand the entity closure process. This involves identifying the authorities that require notification and determining if there is a need to give notice to current suppliers.

It’s important to have this strong understanding of the legal process, as it can reveal whether you need to appoint an authorized liquidator to take care of this step for you.

4. Consider tax components

It’s important for companies to understand whether tax audit is required. In some countries, you cannot simply liquidate. Instead, a tax authority needs to check the accounts beforehand to verify the company can proceed with the liquidation process.

A business may also need to consider if it needs a certificate of good standing from a tax perspective – if you need this certificate, you need to settle any outstanding tax liabilities.

5. Establish timelines

There has to be an understanding of timelines, and there’s a need to establish a budget and plan of execution once the business processes the decisions.

6. Perform health checks

Depending on what the process is going to be and how deeply the tax authorities need to check the entity, the next step is to do a health check of the entity to understand the status from a compliance perspective. For example, companies need to verify all accounting filings and corporate records are up to date.

Before a business can move into any kind of proceedings, it’s important to do what is necessary to correct anything that is not up to date or inaccurate.

7. Understand dependencies and risks

When liquidating an entity, it may be that some employees need to leave as a result, and so businesses need to understand if the employees act as legal representatives or directors and if there is any exposure from this perspective, as before an entity can go into liquidation, it may be that it would like to replace the legal representatives or directors to have a smoother process.

If a business is not liquidating and is instead continuing into different jurisdictions, it needs to understand what the requirements are for that specific jurisdiction and whether it needs a local legal representative, and it must perform all the necessary steps to be able to continue into a different province or territory.

How can HSP help with legal entity rationalization?

HSP helps by describing the process, advising on what the best steps are for liquidation or transforming an entity in different countries, as well as informing on how best to handle changing business formats.

We can perform health checks, look into the existing entities and inform the customers about where they are currently and what corrective actions they need to take to get to the point where they can make the desired changes.

Additionally, we can perform all administrative tasks related to liquidation or company transformation.

HSP also helps customers with potential partners they can work with and puts a project manager in place so they can carry them through the steps, like the planning stage. We act as coordinators, bringing all the loose ends together and ensuring the right sequence of steps.

To find out more about how HSP can help you with legal entity rationalization, or to learn more about our other global business expansion services, please get in touch with us today.

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