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Running a successful business involves understanding the best way to structure your company. You are able to structure 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 company controls or majority-owns another company, that company is a subsidiary company. A parent company or holding company will then control or own the subsidiary. Company 1 will be a subsidiary of Company 2 if they can answer ‘yes’ to any one of the following questions:

  • does Company 2 have the power to appoint or remove a majority of the directors of Company 1; 
  • roes Company 2 have the right to cast more than 50% of the votes that may be cast by the shareholders of Company 1; or
  • does Company 2 own more than 50% of the shares in Company 1?

If Company 2 owns 100% of the shares in Company 1, Company 1 is a wholly-owned subsidiary of Company 2. Generally, Company 2 will be referred to as a holding company if its sole purpose is to hold shares in its subsidiaries. If Company 2 also operates a business, then it is generally a parent company. 

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 which 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. 

For example, the owners of a hairdressing business may operate three different hair salons. Consequently, the owners may set up three subsidiaries. Each hair salon will own the property or the lease of the property where the salon operates from, plus the assets from that salon. It will also be responsible for the operating expenses and liabilities of the individual salon that it owns. 

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. 

From the example above, the business owner may want to give an ownership interest to a salon employee without giving them total ownership of all three salons. In this case, shares can be issued to the employee by the relevant operating company.

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. 

Using 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.

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, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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