Definition:
A subsidiary is a company owned by another company, which is referred to as a parent company or a holding company.
Understanding the concept
Subsidiaries are typically companies owned by a larger organization called a parent or holding company. The parent company has a controlling stake in the subsidiary. If a subsidiary is wholly owned by a larger company, it is called a wholly owned subsidiary. Usually, a subsidiary retains legal and financial independence, but is subject to significant control by the parent company. By acquiring several subsidiaries, the parent company can become a conglomerate.
Example:
Since 2015, the largest subsidiary of Alphabet Inc is Google. This allows Google to focus on Internet-related business, and the Alphabet Inc. Holding company to develop other business areas.
A subsidiary company arises when a holding company acquires more than half of the shares of a given company. A subsidiary may have multiple owners, but it has only one parent company. A fully controlled parent company is called a “wholly owned subsidiary”. Subsidiaries may also be parent companies of other subsidiaries, and such a structure may have several levels of subsidiaries. Large corporations can have subsidiaries both at the national level and internationally to carry out activities in different countries.
For example, Microsoft Corporation owns several subsidiaries around the world, including Microsoft de Argentina S.A. in Argentina and Microsoft Deutschland GmbH in Germany.
What is the purpose of the subsidiary?
A subsidiary is a means to achieve the goals of the parent company. The subsidiary has the following objectives:
1. Using tax advantages
The parent company can use the profits of one subsidiary to compensate for the losses of another, which reduces the total taxable income. It is also possible to create a subsidiary in another state or country with a more favorable tax system.
2. Optimization of operations
A subsidiary located in a particular country or region can manage day-to-day operations more efficiently than a parent company located elsewhere.
3. Reduction of liability
The transfer of ownership and management of assets to a subsidiary allows the parent company to retain limited liability associated with these assets. In the field of commercial real estate, it is common practice to create a limited liability subsidiary (LLC) by the parent company in order to acquire and manage large assets, such as warehouses for storing products or office buildings in the city center.
4. Specific assets
Some subsidiaries can be acquired to obtain specific assets, avoiding the need to repeat their successful formula.
How does the subsidiary work?
For the operation of a subsidiary, it is necessary that the parent company owns more than half of the shares of the subsidiary and controls its activities. If the ownership share is less than half, the company is considered to be associated or affiliated. It is important to know that the financial statements of a subsidiary company differ from those of an associated company.
When creating a subsidiary, it is recommended to contact a state accountant with experience in transferring assets and knowledge of the tax code. The assets and liabilities of the parent company are usually separated from the subsidiary, which protects against creditors’ claims.
How is a subsidiary created?
The process begins with approval by the current management of the parent company. Then a vote must be held, and if a majority of votes support the creation of a subsidiary, the director draws up the decision in writing. For a subsidiary, you can choose one of the two most common types of commercial organizations – a corporation or an LLC.
Different states may have different rules and requirements for the registration and organizational structure of an LLC, so you need to contact a Certified Public Accountant (CPA) and consult the State Chancellery website to get more information about the requirements for your state.
How does the subsidiary function?
The subsidiary often receives a controlling stake from the parent company, which thus provides the start-up capital. This capital is necessary to start the company’s operations.
The parent company usually defines in the charter of the subsidiary the rules of its internal management and its role as the owner. All changes in the charter require the approval of the parent company.
After the election and creation of the board of directors of the subsidiary, the parent company no longer interferes in its activities and the board can function as an independent organization.
The financial statements of the subsidiary are maintained separately from the financial statements of the parent company. However, the subsidiary’s balance sheet and profit and loss statements are often combined together with the parent company’s reports.
Why is a subsidiary being created?
The creation of a subsidiary company allows you to combine the benefits for the parent company. The parent company can control the subsidiary, protect its interests and have separate financial statements. In addition, the consolidation of accounting books makes it possible to compensate for profits with losses and reduce income taxes.
A subsidiary may also provide the parent company with advantages in the form of orderly operations and competitive advantages at the expense of its property, equipment or research and development department. In addition, the subsidiary provides tax benefits and protection from creditors and lawsuits.
What are the advantages and disadvantages of a subsidiary?
One of the notable advantages of subsidiaries is the ability to keep the parent company and the subsidiary as separate entities. This means that the parent company is not legally responsible for the obligations and debts of the subsidiary. Instead, the liability of the parent company is limited to the initial capital, which is exchanged for equity and a controlling stake in the company.
Due to this, the assets of the parent company are usually protected from creditors, provided that there is a clear distinction between the operations of the parent company and the operations of the subsidiary. Such prudent investments allow the parent company to use other growth opportunities.
However, there are some disadvantages. Large-scale organizations, including subsidiaries, require a significant amount of documentation and are subject to bureaucracy. To truly separate these two organizations, each board of directors must act independently. This can delay the decision-making process and the implementation of actions.
What is the difference between a subsidiary and other structures of the company?
Below are a few common terms that have a similar meaning, but differ from the subsidiary:
Affiliate/Associate
A firm is considered affiliated when the parent company has a controlling stake. However, the subsidiary has full ownership of the parent company.
DBA
Unlike a subsidiary, a DBA is not a separate company. It’s really the same company, just operating under a different name. (Doing Business As)
Branch
A branch or division refers to a part of the company that does not operate in the main office. A subsidiary is a separate company.
Sister company
All sister companies are subsidiaries, but not all subsidiaries are sister companies. A sister company is related to another subsidiary because they both have the same parent company. However, a parent company can only have one subsidiary, in which case the subsidiary does not have its own sister companies.
Holding company
A holding company is a term that refers to a parent company, not a subsidiary. The holding company has enough shares to control the subsidiary(stocks), but it does not participate in its daily activities.