A subsidiary is a company owned by another company, usually a parent company or holding company. The parent company controls the subsidiary through an ownership share of voting stock in the company (i.e. greater than 50%). The subsidiary can be acquired by the parent company or be set up by it. When the parent company holds the entire voting stock of the subsidiary (i.e. 100%), that subsidiary is considered wholly-owned by the parent. While this structure offers the parent company control, the subsidiary remains a separate legal entity. This separation pertains to any liability, tax, or other governance matter.
While both a holding company and a parent company have subsidiaries, there is a difference between the two. A holding company does not conduct operations of its own. In other words, the purpose of a holding company is in the structure and control it offers. A parent company, on the other hand, does conduct operations of its own, which are separate from those of the subsidiaries.
The most common reason to form a subsidiary is for asset protection. This is why subsidiaries are common in risk-prone industries like real estate. It is common practice for a real estate company to own several properties under the structure of a holding company in order to separate the liabilities of the subsidiary properties and protect the company assets.
There are several reasons why companies choose a subsidiary model. Here are some of the most common advantages that subsidiaries offer:
Limited Liability for Parent Company
The limited liability offered by the parent/subsidiary structure is
the most common advantage companies seek with this model. If the
necessary steps have been taken to ensure proper structuring and
management in this scenario, then the parent company should be
shielded or limited from any potential losses of the subsidiary.
Separated Management Structure
Another attractive advantage offered by the subsidiary model is the
opportunity to have multiple businesses operating with their own
management structures. While each of the businesses is technically
controlled by the parent company, each has the flexibility to play to
their own strengths. This is helpful for both operations and the
ability to take advantage of industry or location-specific
opportunities.
Unique Identities or Brands
It is not uncommon for a company to seek expansion or diversification,
while still wishing to retain the identity that has brought them
success to-date. In such a case, the company would likely consider use
of a subsidiary to solve this matter. The subsidiary is able to take
on its own identity or brand, while the company still retains control
and enjoys the subsidiary’s successes.
Beneficial Tax Purposes
All companies keep a watchful eye on how taxes affect their business.
Some states tax only the profits made by a subsidiary instead of a tax
on the total made by the parent company. In this case, a company may
determine there is a benefit to conducting subsidiary operations in
those states. It is common practice for multinational companies to
seek out lower rates through incorporating subsidiaries in
tax-friendly countries.
Beneficial Investment Purposes
In some cases, a subsidiary may provide you with beneficial
investment
opportunities. Depending on the structure of your subsidiary, it can
be possible to reduce regulation and compliance requirements.
Additionally, your subsidiary structure may make your business more
appealing to investors or provide greater ease in the event of a
merger through reduction of your company’s income tax payable.
While the subsidiary model does offer many advantages, there are a few potential disadvantages to consider. Some of these disadvantages include:
Cash Flows
Even though the parent company has control of the subsidiary, there is
the possibility that the parent does not have full access to the
subsidiary’s cash flows, depending on how management and control is
structured.
Linked Reputation
In some circumstances, the parent company and subsidiary may have a
linked reputation, even while operating separately or in different
industries. In this case, the parent company may feel obliged to come
to the aid of the subsidiary in order to uphold its reputation.
Complex Regulations
Naturally, as you expand your business, you will face more regulation
and compliance rules. In the case of subsidiaries, compliance tends to
grow in complication and often requires professional legal, tax, and
accounting assistance. It is smart practice to seek out a professional
for both forming and maintaining your subsidiary to ensure an accurate
navigation of any and all regulations.