Running a successful business involves understanding the best way to structure your company. If you are looking to expand your business operations, you can consider structuring your businesses so that there are multiple companies within the same corporate group. The main advantage of this structure is to separate assets or divisions of a business and ringfence liabilities. One way to structure your businesses is through the parent-subsidiary relationship. This article will explain what a subsidiary company is and the reasons for structuring your business using subsidiaries.
What Makes a Company a Subsidiary?
Where a larger company controls or majority-owns another smaller company, that smaller company is a subsidiary company. A parent company or holding company will then control or own the subsidiary.
A company may also be an indirectly held subsidiary of an ultimate holding company. This structure occurs if a company is a subsidiary of another company that is already a subsidiary of an ultimate holding company. If a company owns less than 50% of the shares in another company, it will be called ‘affiliates’, ‘associates’ or ‘related entities’.
Using Subsidiaries to Separate Businesses
A large or diverse business that operates from different sites or consists of different aspects may be structured using subsidiaries.
The holding company may decide to own various subsidiaries if it gains businesses by way of purchasing the entire share capital of the operating company of those businesses.
Why Separate Business?
An advantage of this structure is that if one subsidiary company is in financial difficulty, the others are safe from external creditors. In the example above, if one hair salon is unable to repay its debts, a creditor claiming against the company is unable to recover any amounts from the other salons. The other salons are protected by virtue of being held in separate subsidiary companies. An exception to this is if a subsidiary has given a guarantee concerning the obligations of another subsidiary. In this case, it will be liable for the debts of the other company.
A holding company will fully own each of its subsidiaries. The purpose of this structure is solely to hold the shares within the subsidiaries.
The operating company will still be a subsidiary of the holding company for so long as it owns at least half of the shares (or satisfies one of the other tests set out above). If multiple shareholders own a subsidiary, it is good practice for the holding company to enter into a shareholders’ agreement. Likewise, the minority shareholders should govern the relationship between the shareholders and set parameters around the operation of the business by its Board.
Continue reading this article below the formUsing Subsidiaries to Separate Key Assets
Equally, a smaller business that carries only one operation may have key assets that it wishes to protect. To do so, it may set up a holding company structure. This usually consists of one holding company and one wholly-owned subsidiary.
The key asset, for example, a trademark or a franchising contract, will be owned by the holding company. The business will be owned and operated, and all liabilities will be incurred, by the subsidiary. Hence, any key assets are safe from any claim brought against the operating entity because the subsidiary does not own it.
Is a Branch or Division the Same as a Subsidiary?
A subsidiary is a separate entity with its own legal identity. It can enter into contracts, own assets, incur liabilities and employ staff.
Both a branch and a division are part of a company and are not separate entities. Usually, a branch runs part of a business in a different location to the rest of the company. The term division typically refers to an arm or specific operation of a business. If you are entering into a contract which relates to a branch or division, it will be entered into by the company that operates the branch or division.
Accounting and Tax Treatment
Each subsidiary in a group is a separate company which will have its own assets and liabilities. Hence, each subsidiary should keep separate financial records. There may be transactions between a subsidiary and its holding company or other companies in its corporate group. For example, you should record any payments for shared services.
Equally, each subsidiary may be treated as a separate company for tax purposes. However, it is possible for holding companies to prepare consolidated financial statements. These statements reflect the assets and liabilities of all of the subsidiaries in its group. Additionally, it may also be possible to submit income tax returns on a consolidated group-wide basis.
You should contact your accountant or financial adviser to find out whether your business can submit income tax on a consolidated basis.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
Key Takeaways
Where a company controls or majority-owns another company, that company is a subsidiary company. Subsidiaries can be useful to:
- ringfence businesses and assets from the rest of a corporate group;
- separate your business into several small individual businesses; or
- to protect key assets.
If you are considering to structure your businesses through the parent-subsidiary relationship, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A subsidiary is a company under the control of another company. It runs the day-to-day operations and may incur liability.
Creating subsidiary companies and a parent company can compartmentalise business structures and assist with risk reduction.
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