Updated: Jul 8
What is a Subsidiary
A subsidiary is a company that is wholly owned or partially controlled by another company.
The other company is called the parent or holding company. The subsidiary is said to belong to the parent company as it has a controlling stake in the it.
A subsidiary is said to be wholly owned if it is 100% owned by the parent company. Conversely, ownership of at least 51% also represents control.
Why Companies Set up Subsidiaries
Here are some practical examples of reasons for establishing a holding company/subsidiary relationship:
In order to maintain the independence of the brand identity, companies can establish subsidiaries. This helps all brands maintain relationships with suppliers as well as goodwill with customers. By keeping separate brand entities, it is easy to organize the company culture and differentiate the different brand entities.
To Raise Funds
By taking ownership of a subsidiary, the parent company can offer its percentage stake in the subsidiary and drive investment. In this way, the parent company can raise capital without the risk of altering the value of the parent company's stock.
Since each subsidiary has its own business, the parent company can sell unprofitable subsidiaries without any impact on the parent company. Due to the division of operations, the creditors of a subsidiary can only sue the subsidiary with which they signed the contract.
Reporting and Strategic Disclosures
It allows the parent company to choose which aspects of the business should be made public or kept private if the business of the parent company is separated from its subsidiaries. This often helps if the parent company is in a highly competitive industry and is reluctant to disclose new product lines.
Advantages and Disadvantages of Subsidiary Structure
Mitigation of risk through subsidiaries
As mentioned earlier, it is a separate and distinct legal entity which reduces risk. There is no transfer of losses from subsidiaries to the parent company. However, in the case of bankruptcy, where it can be proved that the parent company and the subsidiary company are legally and effectively the same company, their obligations may be assigned to the parent company.
Improved efficiency and diversification through subsidiaries
Creating a subsidiary allows the parent company to achieve greater efficiencies by breaking up larger companies into smaller and more effectively managed companies.
Limited control over subsidiaries
If the company is not wholly owned by the parent company, meaning it is partially owned by other companies, the parent company may have management control issues with its subsidiaries. In fact, decision-making is also difficult because issues must be decided through the proper chain of command within the parent company structure before any action can be taken.
Fees for setting up a subsidiary
The extra paperwork and administration can be costly and put a burden setting it up and in filing your taxes.
No tax consolidation/group relief
Hong Kong does not allow the filing of Consolidated Returns. In Hong Kong, there is no concept of grouping for tax purposes. Companies within the same group must file tax returns and pay taxes separately. All companies are assessed individually, whether they are group companies, associates or related companies.
Hong Kong has no group relief for members of the same group. Hong Kong tax law does not provide for group relief of losses. For tax purposes, each company within a business group is considered and taxed as a separate entity. This means that losses may not be passed on to other group members for utilisation.
Attributes of a Subsidiary
A subsidiary is a separate entity or company from its parent or holding company. It can sue and be sued in its own name and independently of its parent or holding company. The company has its own responsibilities and obligations, and the parent company is not liable for its subsidiaries.
As stated above, the parent company should own at least 51% of the subsidiary to have ownership of the subsidiary. The ownership percentage will give the parent company the right to exercise control in corporate decisions.
Parent and subsidiary companies do not have to be in the same location to do business. In addition, the parent company and subsidiary company do not have to conduct business in the same line. The subsidiary company may also have its own subsidiaries. In this case, the subsidiary will act as the parent company for its subsidiaries.
How Subsidiaries Work
The subsidiary is created to provide sufficient separation and certain synergies for the two companies. This synergy comes in the form of tax benefits, risk diversification, income in the form of assets, property or equipment. While these are set up by the parent company, the subsidiaries are separate from the parent company.
This means that the subsidiary bears responsibilities in its own name and has its own taxation and governance. If the subsidiary is incorporated or owned by the parent company in a foreign jurisdiction, the laws of the country in which the subsidiary is incorporated and operates apply.
A parent company has a controlling interest in, and exerts significant influence over, a subsidiary. Its board of directors is elected by the parent company along with other shareholders of the subsidiary.
There is a difference between buying a subsidiary interest and amalgamating. In the case of a purchase, the parent company's investment is smaller and shareholders' approval is not required to turn the company into its merger event. Selling it also doesn't require a vote.
To become a subsidiary, the parent company must hold at least 51% of the shares. Those below this percentage are not called subsidiaries, but called associates or affiliated companies. Associates are treated differently when it comes to financial reporting.
Some Examples of Subsidiaries
In the digital industry, one of the most popular examples is Facebook. It owns many subsidiaries as it has several investments in other companies and acts as the parent company for these subsidiaries. In 2012, Facebook acquired social media app Instagram. In 2014, it also bought popular messaging app WhatsApp and bought a stake in virtual reality company Oculus.
Google restructured in 2015 and established Alphabet as the holding company above its various subsidiaries such as Google & Nest.
Tata Consultancy Services is a subsidiary of the Tata Group.
Jio belongs to Reliance Group.
Motorola, acquired by Lenovo.
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