A company whose control lies with another company is called a subsidiary company. The company controlling the subsidiary company is called a holding company. The holding company owns a majority of the shares of the subsidiary company, and thus, exercises control as the majority shareholder or has a controlling interest in the company. Holding companies are generally called parent or umbrella companies. In most cases, these companies’ main role is to oversee subsidiary companies and make management decisions instead of partaking in the day-to-day business of the subsidiary company. Because the holding company is making management decisions, this in turn means that it is controlling the policy-making in the company. It is also more convenient for holding companies to only have a shareholding instead of working with the subsidiary because if the latter goes bankrupt, creditors cannot go after the holding company to satisfy their debts. This paper will analyze what a subsidiary company is and some of its advantages.
If a holding company has 100% shareholding in a subsidiary, it is called a wholly-owned subsidiary. Otherwise, whenever a subsidiary company is referred to, it is to be assumed that the holding company owns from 50% to 99% of the shareholding in the subsidiary. If the shareholding is less than 50%, then it is an associate company. This subsidiary company can be acquired or established by the holding company. Subsidiary companies can only be understood in reference to holding companies. Companies Act, 2013 defines a subsidiary company as a company in which the holding company controls the composition of the board of directors and controls or exercises more than half of the total share capital of the subsidiary company.[i] Even if this control exercised on the subsidiary company is not done directly by the holding company, for example, if this control is exercised by another subsidiary of the parent or holding company, even then it will fulfil the conditions to be a subsidiary of the main holding company.
If another company is able to manipulate and change, that is in all exercise some amount of power over the composition of the Board of Directors of a company, they are able to at their discretion remove or appoint a majority of the directors, then the board of director is deemed to be controlled by the other company. So, for example, company A owns the rights to make changes to the board of directors in company B, and company B in turn has the same rights with respect to Company C. In this case, company A is the parent company for both company B and C because the ultimate power of decision making in company B including concerning company C lies with Company A. However, it is to be noted, that the subsidiary exists a separate legal entity from the holding company. So, in the above example, if either company B or C is sued by someone, Company A will not have any form of liability, unless the corporate veil is pierced.
Subsidiary companies can come into existence in two ways,[ii]
- Either through a process of mergers and acquisitions, that is through merging with the parent company or getting acquired by the parent company.
- Or if the holding company created a smaller company to handle the specificities of their operations, so they can focus on other aspects of their operations and strategies.
The power of a holding company over a subsidiary depends on the relationship between the two. There are two different ways of governing the subsidiary company –
- Horizontally integrated: here, all companies, that is the holding company, any of its subsidiaries and any other associate company all operate on the same level.
- Vertically integrated: here, the parent companies own several companies all of which involve a product or supply chain.
If a holding company’s main business is only to govern the work of the subsidiaries, it is called a pure holding company.[iii] However, if the holding company other than holding ownership of the subsidiary runs its own operations, it is called a “mixed” holding company. For example, YouTube is a subsidiary of Google, but Google has its own works other than having ownership of YouTube, so it is a mixed holding company.
Some advantages of subsidiary companies include:
- Tax benefits: Generally, subsidiaries get tax benefits, this can be most seen in the case of when the subsidiary is established in another country, due to the existence of Double Taxation Avoidance Agreements. In some cases, companies are able to get out of paying tax completely due to their arrangement.[iv]
- Non-profit benefits: When the parent company is a non-profit organisation, it can still have a subsidiary company which is a for profit company. Therefore, it will be able to generate profits despite being a non-profit company.
- Brand recognition: Subsidiaries can create their own brand recognitions once they get popular, which in turn also benefits the holding company.
- Increased diversification and efficiencies: By dividing the work chain, subsidiaries help with achieving greater operational efficiency.
- Separate legal identity: Since the subsidiary exists as a separate legal entity, the holding company does not have to worry about the debts of the company, because the creditors cannot start an action against them.
However, there still exist some disadvantages to having a subsidiary company
- More liability
The holding company is generally is separate from the legal liabilities of the subsidiary company, however, if the corporate veil is pierced,[v] since it holds the major amounts of shares in the company, it will have some liability.
- Complex financials:
Accounting is more difficult when it comes to accounting the holding and subsidiary accounts together. Especially if the holding company has multiple subsidiaries.[vi]
- Different legal regulations
If the subsidiaries are established in different countries, then the holding company needs to be aware of the legal system in these different countries, and general laws for companies differ per country.
In the USA subsidiaries can be of 2 types:
- Subsidiary LLC: LLC stands for Limited Liability Company. Here, the parent company is able to stay from the toxic assets of the subsidiary which could lead to potential legal issues. This can be a privately held corporation.
- Subsidiary corporation: Here, the holding company will have limited personal liability for the debts of the company. The profit is divided among the corporation and owners. And stocks can be sold to raise capital.
In India, much like normal companies, subsidiaries can either be public limited or private limited, following the same regulations for companies which are not subsidiaries. To set up a subsidiary company in India the normal process of setting up a company has to be followed and the same needs to be followed by the company trying to establish a subsidiary in the country. In India, it has been held that even where the company was wholly owned by the holding, since the source of income was different the holding company was not liable.[vii] Thus, it is generally more beneficial for holding companies to have subsidiaries companies, as it helps them organize their business help and has more advantages than disadvantages.
[i] Companies Act, 2013, Section 2(87).
[ii] Business central, ‘What is a Subsidiary Company?,’ (Microsoft), < https://dynamics.microsoft.com/en-us/business-central/what-is-a-subsidiary-company/ > Accessed 18th October 2022.
[iii] Jean Murray, ‘What is a Subsidiary Company?,’ (The Balance, June 2020), < https://www.thebalancemoney.com/what-is-a-subsidiary-company-4098839> accessed 18th October 2022.
[iv] Union of India & Anr. v. Azadi Bachao Andolan, Decided on 7 October 2003, Case No. 8161-8162 of 2003.
[v] Salomon v. A Salomon Co. Ltd., 1897 AC 22.
[vi] Indeed Editorial Team, ‘What is a Subsidiary and How does it work?,’ (Indeed, February 2020), < https://www.indeed.com/career-advice/career-development/subsidiary> Accessed 18th October 2022.
[vii] APSRTC v. ITO, 1964 7 SCR 17.
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