What is a subsidiary?

In the world of business, the term “subsidiary” refers to an organization that belongs to another business and is often known as the parent company or holding company.

The parent has a majority share in the subsidiary, meaning it owns or has control over more than 50% of its shares. If another company owns the subsidiary, it is known as an entirely owned subsidiary. Subsidiaries are crucial when discussing reverse triangle mortgages.

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What are the characteristics of a subsidiary?

A subsidiary is an individual and distinct company concerning its parent company. This helps the company in terms of taxation and regulation and liability. The sub can pursue and defend itself independently in relation to its parent. The sub’s obligations are typically the sub’s responsibility and are not typically a responsibility for the company’s parent.

The minimum ownership level of 51% gives the parent company with the required votes needed to establish the boards of the subsidiaries. This permits the parent company to have control over the company’s decision-making.

Sub-companies and parents do not have to be in the same area and are not within the same industry. Subsidiaries can also own their sub-companies The line of succession creates a corporate group with different levels of ownership.

Benefits

#1 Tax benefits

A parent company can significantly lower tax liabilities with deductions that are permitted from the government. If a parent company has multiple subsidiaries, the tax taxes due to gains from one sub is usually compensated by losses in another.

#2 Risk reduction

The parent-subsidiary model reduces risks because it provides the separation of legal entities. Any losses that a subsidiary incurs are not immediately transferred into the parent. If a company goes bankrupt, however, the obligations of the subsidiary could be transferred to the parent company if it is proven by the court that the parent and subsidiary are legally one and the same.

#3 Increased efficiency and diversification

In certain instances, the creation of subsidiary silos allows an organization’s parent to attain higher efficiency in its operations, by breaking up a large corporation into smaller, easier to manageable units.

Negatives

#1 Control is limited

A parent could face issues with management control of its subsidiary if that sub is partly owned by different entities. It is also possible that decision-making becomes complicated since issues need to be resolved through the hierarchy of control within the bureaucracy of the parent before action is initiated.

#2 Legal costs

A long and expensive legal document burdens arise in the formation of a subsidiary company and tax filing.

An example of a Subsidiary Structure

One well-known and reputable parent company in the world of digital is Facebook. Apart from being publicly traded in the open marketplace, Facebook also holds several investment portfolios with other companies that are part of the field of social media and is the parent company of several sub-companies in software technology.

Some examples of Facebook sub-companies include:

  • Instagram, LLC is a photo-sharing website acquired from Facebook on April 12, 2012, for around US$1 billion in cash and shares. Instagram is distinct from its operations management, and is managed by Kevin Systrom as CEO.
  • WhatsApp Inc. — Facebook purchased this popular messaging app for around US$19.3B in 2014.
  • Oculus VR, LLC in March of 2014, Facebook signed an agreement to acquire shares of $2 billion of the company that makes virtual reality, Oculus.

Subsidiary against. Division or Branch

You might have heard the words “branch” or “division” that are alternatives to “subsidiary,” but they aren’t the identical. A subsidiary is an independent legal entity, whereas branches or divisions are an element of a larger company that is not considered independent.

A branch is generally described as a distinct location within the business, such as that of the Pittsburgh branches of a corporation with its headquarters in New York. A division is a part of the company responsible for executing an specific activity, for example, the wealth management department that is part of the larger financial service business.

Holding Company vs. Parent Company

The majority of holding companies’ primary function is to control the ownership of their subsidiaries. If that’s the case, the company is described as a “pure” holding company. If it also has business operations in itself, then it’s referred to as an “mixed” holding company. A good example of a pure holding firm is the publicly listed Alphabet Inc., whose function is to house Google as well as other lesser-known subsidiaries, such as Calico or Life Sciences. YouTube is itself a part that is part of Google. 7

A parent company is a company that has it’s own operations in business, as and subsidiaries that manage their own businesses. A good example of this is Facebook Inc.: Instagram LLC, Oculus VR LLC along with WhatsApp Inc. all became part of Facebook Inc. After Facebook purchased these companies.

Principal Takeaways

  • A subsidiary is owned and controlled by or at a minimum majority-owned by a parent company or holding company.
  • A subsidiary may be created in a variety of kinds of companies.
  • A subsidiary is the one that produces its own accounting statements, and is able to prepare its own tax returns. But, public-traded corporations with at least 80% of their subsidiaries are able to submit consolidated tax returns to allow them to offset the profits of certain subsidiaries against losses from other subsidiaries.
  • A holding company generally doesn’t run its own business activities. However, a parent company has its own business separate from the activities of its subsidiaries.
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