What's a Subsidiary
Companies can own all or part of other companies. When you own enough equity in a company, you get to make decisions about how that company is run.
Equity can be defined as stock or any other security representing an ownership interest in a company. If 51% or more of a company's equity is owned by one party, that is called a controlling interest.
If company A owns a controlling interest in company B, company A is called the parent company and company B is its subsidiary.
For example, the Kellogg company owns a controlling interest (51% or more) in the Eggo company. So, the Eggo company is a subsidiary of the Kellogg company.
Subsidiaries, Associates, and Affiliates
Often times, a parent company will have multiple subsidiaries. In these cases, the subsidiaries are referred to as sister companies to one another.
Two subsidiaries of Kellogg company are Kashi company and Eggo. Kashi and Eggo are, therefore, sister companies to one another.
There are, of course, other types of company links. For example, if one company owns more than 20% and up to 50% equity in another company (less than a controlling interest), the second company is called an associate company.
In a situation where a parent company has associates and subsidiaries, those companies are referred to as affiliates of one another. Consequently, a company can be an affiliate of its sister companies and also of the parent company.
These terms can be quite confusing and people often use them loosely. But, the difference between them can be very important. This is because the relationship between two companies can determine, among other things, how the liabilities of one company may affect the other.
How Subsidiaries Work
A subsidiary can be structured as a limited liability company (LLC), S-corporation, C-corporation, etc. A subsidiary can even be a nonprofit organization. But, regardless of its structure, forming a subsidiary can sometimes be very complicated.
When your company exists and operates independent of other companies, it only has to worry about its own affairs. However, when your company has one or more subsidiaries, things can be a lot more complicated.
To begin with, you must maintain separate financial records for your parent company and each of your subsidiaries. Transactions may take place within the corporate family, but each subsidiary will operate independently of the others. Furthermore, the way each subsidiary is managed may differ greatly, with various degrees of autonomy among them.
The Accounting and Tax Consequences of a Subsidiary
From an accounting perspective, a subsidiary is an independent entity and, therefore, has its own assets, liabilities, bank accounts and maintains its own financial records.
Likewise, a subsidiary is an independent entity for tax purposes. Every subsidiary has its own tax number and pays its own taxes, based on its particular business entity structure.
The Advantages of Forming a Subsidiary
There are a number of advantages that come with forming a subsidiary:
Limited Liability is the most common reason companies form subsidiaries. Provided that the corporate affairs of the parent company and the subsidiary are kept separate, the parent company's liability for the affairs of its subsidiaries will be limited and the subsidiary will act as a kind of liability shield for the owners of the parent company.
Whenever a company needs to diversify its commercial identity without jeopardizing its primary identity, it can consider forming a subsidiary. This is not uncommon with clothing companies that want to market different fashion labels, each having its own identity that is different than that of the parent company.
Forming a subsidiary gives a business the benefit of having multiple entities in the same market––each having its own management structure. For instance, a multinational company can form a subsidiary in a country that is different legally and culturally from its home country. This subsidiary will be better able to adapt to the local legal and cultural environment and can develop a management approach that is best suited to that country.
If a subsidiary is set up properly, it can reduce regulatory requirements, rendering the company more attractive to investors. Furthermore, it can make mergers easier and even enable part of one subsidiary to be sold to another.
Taxes are another common reason why companies choose to form subsidiaries. In some states, a subsidiary is only taxed on the profits it generated in that state, rather than the total profits of the parent company. Furthermore, a multinational company can also benefit from lower tax rates in another country by forming a subsidiary there.
Disadvantages of Forming a Subsidiary
There are also a few disadvantages to forming a subsidiary:
- Depending on how much control the parent company enjoys over the subsidiary, it may have only limited access to the subsidiary's cash flow.
- The subsidiaries reputation may jeopardize that of the parent company.
- The parent company may be directly exposed to the liabilities of a subsidiary if the parent company guarantees the subsidiary's loans.
- Occasionally, a parent company may be held liable for the actions of a subsidiary if the subsidiary is an operating company and subject to a lawsuit or criminal prosecution.
For more detailed information on subsidiary companies and the advantages and disadvantages of forming one Wyoming, contact an experienced Wyoming business law attorney today for a free consultation.