Setting up a subsidiary company isn’t a decision that business owners take lightly, but it can have significant advantages for an organisation.
As a subsidiary company operates separately from its parent company, a subsidiary company can benefit the organisation it belongs to in terms of taxation, regulations and financial liabilities. It can also be sued separately from its parent company, and sue separately of the parent company, whilst its obligations remain its own and do not become a liability of the parent company.
Parents and sub-companies also do not need to operate in the same location, or even be in the same industry. Subsidiary companies can even form their own sub-companies.
If you’re a business owner considering the same decision, read on to find out more about subsidiary companies and how to set up your own.
Read more: How to Set up a Brand New Limited Company
What is a subsidiary company?
A subsidiary company refers to a company that is owned either partially or wholly by another company.
The company that partially, or fully owns, the subsidiary company is referred to as either the parent company if it has other business operations, or as the holding company if the sole purpose of the company is to own subsidiary companies.
Where the stocks and shares of the subsidiary company are concerned, the company will have over 50% of its voting stock controlled by either the parent company or the holding company. This is for liability, tax and regulatory reasons as the subsidiary and parent company remain separate legal entities.
A minimum level of 51% ownership will guarantee the parent company the amount of votes required to to configure the subsidiary’s board. This then guarantees the parent company the right to exercise control in the subsidiary company’s decision making.
What is the purpose of a subsidiary company?
The purpose of a subsidiary company differs depending on the reason that it has been established, and these reasons are often bespoke to either the holding or parent company.
Subsidiary companies are identified as separate legal entities from their parent companies, which means their tax, regulation and liability obligations are protected. This can be a driving purpose in industries such as real estate or property management.
For example, a parent company that owns properties and has apartments for rent may form an overall holding company and connect each property as a subsidiary company. The reason behind this is the assets of each property are then protected from one another’s liabilities. I.e if one of the properties is sued, only that property’s assets are vulnerable, and not the assets of the other properties, nor the holding company.
Outside of the real estate market, subsidiary companies can serve a number of different purposes. These can be anything from accessing foreign markets that would otherwise be closed to the parent company, to acquiring and controlling other companies that are used in the production and manufacturing of the parent companies goods.
Some businesses simply set up subsidiaries just to diversify the business, protect financial liabilities and to differentiate any separate brands included in the parent company.
What are the advantages and disadvantages of a subsidiary company?
Whilst setting up a subsidiary company does allow the parent company to benefit from some distinct advantages, there are potential disadvantages to be aware of.
Some advantages of setting up a subsidiary company are:
- Tax benefits
As previously mentioned, parent companies can substantially reduce their tax liabilities by owning subsidiary companies. Parent companies that own multiple subsidiaries can often offset high income tax liabilities against losses made in another subsidiary.
- Separation of legal entities
A parent-subsidiary relationship negates the risk because of the creation of separate legal entities. Any losses incurred by a subsidiary will not transfer to the parent. However in the case of bankruptcy the subsidiary’s obligations may be assigned to the parent if it is proven that the parent company and subsidiary company are effectively one and the same. I.e: The subsidiary company is simply an arm of the parent company.
- Business diversification
Some parent companies will achieve greater operational efficiency if they split their company into smaller subsidiaries. Small subsidiary companies that can be established in separate locations may allow access to different markets or distribution channels that were not previously available to the parent company.
Meanwhile the disadvantages of setting up a subsidiary company are:
- Limited control
In some cases parent companies may run into management control problems with subsidiaries if the subsidiary is only partially owned by the parent company, and partially owned by other entities. The chain of command for decision making may become somewhat tedious because issues will need to be decided within the parent bureaucracy with a substantial amount of votes before action can be taken.
- Legal costs
Unfortunately setting up a subsidiary company does come with both lengthy, and costly, paperwork. This is both from the formation of a subsidiary company and from filing in the necessary tax paperwork.
How to set up a subsidiary company
Whilst subsidiary companies can either be partly or wholly owned by another company, it is not like trading under a different name and so the subsidiary must be incorporated as if it is another company.
To incorporate a subsidiary company through Companies House directors must:
- List the parent company’s registered office address
The office address must be in the country in which the subsidiary company is being incorporated in.
- Identify a sole director
To set up a subsidiary company, only a sole director needs to be appointed. The only restriction when appointing a sole director is that the director can not act as the company secretary. Sole directors must also enter both their residential address and a service address, but only the service address will appear in the public forum.
- Ensure an even ownership split between a director and a company
In the various documentation that is submitted with regards to shareholders, an individual director and another company must both act as shareholders. Entire companies are prohibited from being owned by another company.
Once all the documents have been submitted, a decision will be made by Companies House within 24 hours.
Setting up a subsidiary company isn’t a decision to be taken lightly. Depending on the specific purpose of the business, it may be more convenient to open a new company from scratch. Other reasons could include:
- Your parent company will be operating overseas. Companies will often opt to incorporate a subsidiary company in another country if the parent company will be based overseas. There are tax, administrative and market entry advantages to this.
- You have two completely different businesses. Sometimes businesses diversify to a point where entirely different arms of the businesses need to be formally identified and separated.
- Team Differences. Sometimes parent companies create subsidiaries if they are working on dramatically different projects within their industry. The projects may not be relevant to the business’s primary purpose, so a subsidiary allows for a formal separation.
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