The word “subsidiary” gets tossed about a lot in the world of business. But what does it really mean? A subsidiary is a company owned or controlled by another business entity (known as a parent company, holding company, or umbrella company). A parent company might own all of a subsidiary or achieve control by having a majority ownership stake (i.e., over 50%).
Because the parent company has a controlling interest, it has a say over its subsidiary company’s governance. For example, the parent company will elect the subsidiary’s board of directors.
Although a parent company may influence its subsidiary’s oversight and operations, the two companies are separate business entities responsible for their own management, debts, legal issues, and other matters. Most parent companies and their subsidiaries are set up as C Corporations or Limited Liability Companies (LLCs).
Advantages of a Subsidiary Company
Below are some benefits of having a subsidiary:
- Helps Limit Liability – A subsidiary is a distinct legal entity from its parent company. That separation means both companies have limited shared liabilities and are regulated and taxed independently. That arrangement helps protect the holding company if the subsidiary encounters legal issues or financial hardships.
- Enables Expansion – Creating or buying a subsidiary corporation or LLC allows a parent company to expand into other markets while minimizing the overall business risks. Also, acquiring a company as a subsidiary can allow a parent company to gain specialized expertise and capabilities without doing intensive research and development.
- Pools Resources – While a subsidiary typically operates on its own, its connection to its holding company provides resources it might not otherwise have access to.
- May Have Regulatory and Tax Advantages – As its own business entity, a subsidiary corporation or LLC located in a different state or country from its parent company may benefit from more favorable regulations and tax rates. The subsidiary follows its jurisdiction’s laws and tax code rather than its parent company’s.
- Offers an Opportunity to Diversify – Many subsidiaries are operated and marketed as separate brands from their holding companies. They have their own brand identity, customer base, and reputation. Having a subsidiary gives a holding company the means to diversify its offerings and branch into different niches without creating confusion in the marketplace.
Disadvantages of a Subsidiary Company
Along with their benefits, subsidiaries have some potential downsides:
- More Complicated Accounting and Taxes – Tracking financials, managing finances, and filing tax returns for a holding company with subsidiaries can get complex. This is especially true when a holding company owns multiple subsidiaries. An experienced accountant and tax advisor can help ensure books and tax filings are correctly handled.
- Additional Costs – Forming a separate legal entity means paying a filing fee to register the subsidiary and paying fees associated with other requirements (including ongoing compliance to keep the entity in good standing).
- Introduces More Legal Considerations – Setting up a subsidiary shields a parent company from potential losses, but it can also require understanding different regulations and laws. A subsidiary must abide by the government and tax agency laws and compliance requirements specific to where it operates. Guidance from an attorney can help ensure business owners understand their responsibilities and compliance obligations.
- Might Cause a Power Struggle – When a parent company does not wholly own a subsidiary, it may struggle to influence positive change if the subsidiary is poorly managed. Decision-making must go through multiple shareholders and a proper chain of command. Even with a wholly-owned subsidiary, conflicts can occur. The subsidiary has its own management structure, and individuals may resist or resent a parent company’s intervention.
How to Set Up a Subsidiary Company
A business entity can create a subsidiary company or become the parent company of an existing business by buying majority shares.
The steps for forming a new subsidiary LLC or Corporation vary depending on the state. It’s critical that owners of the holding company carefully research the requirements and get professional guidance from an attorney and tax advisor.
Below, I’ve listed parts of the process that apply to most companies when setting up a subsidiary:
- Approve the Subsidiary – Typically, the parent corporation’s board of directors or parent LLC’s members will vote on forming the subsidiary company at their board of directors or member meeting. The results of the vote are included in the meeting minutes. Also, a resolution (signed by the board chair or an authorized LLC member) is drawn up to make the agreement official.
- Register the Business Entity – The subsidiary must be registered in the state where it will operate. Usually, this will be the state where it’s physically located. Through the incorporation or LLC formation process, the holding company is identified as the owner. Before filing Articles of Incorporation or Articles of Organization with the state, the subsidiary must designate a registered agent to receive service of process and other official documents on its behalf. Some states have other requirements as well. For tax purposes, the subsidiary must obtain an EIN and possibly apply for state and local tax ID numbers.
- Create a Governance Document – Processes and procedures for operating and managing the subsidiary are formalized in corporate bylaws or an LLC operating agreement. These internal governance documents help keep everyone on the same page and prevent misunderstandings. They explain owners’ and other stakeholders’ roles and responsibilities, set rules for how the business should be run, and describe how various situations should be handled (e.g., if a shareholder wants to sell their ownership interests or members disagree with some aspect of how the company is managed).
- Form a Board of Directors – If the subsidiary is incorporated as some form of Corporation (e.g., C Corporation or Nonprofit Corporation), it must form a board of directors according to the state’s requirements and the Corporation’s bylaws.
- Apply for Business Licenses – As its own entity, a subsidiary is responsible for obtaining the licenses and permits required to operate the business. Depending on the industry, type of business conducted, and location, licensing might be required at the federal, state, or local level (or all three).
- Fund the Subsidiary Company – A subsidiary needs money to operate like any business. By transferring assets to the subsidiary, the parent LLC or Corporation achieves ownership interest in the company. The subsidiary will issue a stock certificate (if a Corporation) or an LLC membership certificate (if a Limited Liability Company) to the parent company.
- Keep Up-to-Date Financial Records – Both the parent company and the subsidiary must record any transactions between the two. A subsidiary will maintain separate accounting records as well as have its own financial statements, and its parent company might need to include them in consolidated financial reports. The accounting rules regarding consolidated reporting that a parent company must follow depend on the type of business and percentage of ownership in the subsidiary.
- Maintain Compliance – A subsidiary must comply with all relevant business compliance requirements. These may differ depending on the state, business entity type, and other factors. CorpNet’s online compliance monitoring tool can help ensure business owners don’t overlook their responsibilities (such as renewing business licenses, filing annual reports, and holding annual meetings).
What is a wholly owned subsidiary?
When a subsidiary is 100% owned by a parent company, it’s called a wholly owned subsidiary. The parent company holds all common stock in the subsidiary, achieved by either forming the subsidiary or acquiring full control of the company. In a wholly owned subsidiary, the parent company has direct control over appointing the subsidiary’s board of directors, thus giving it a high degree of influence over the subsidiary company.
What’s the difference between a subsidiary and an associate or affiliate company?
When a business has partial but not majority ownership of another company, the company is referred to as an associate or affiliate company. Generally, an associate or affiliate company has between 20% to 50% ownership.
How is a subsidiary company different from a branch?
The most significant difference between a subsidiary and a branch is legal separation. A subsidiary is its own legal entity whereas a branch is an office or other physical presence that a company sets up at a location other than its primary location. A branch is considered the same legal entity as the main business. Therefore, the parent company controls all aspects of the branch and is responsible for all legal and financial debts of the branch.
Can a subsidiary be a Corporation or LLC?
The parent company decides on its subsidiary’s legal business structure. Both legal, tax, and administrative considerations will affect the decision. Both LLCs and Corporations limit the liability of the parent company, but those structures are taxed differently and have different startup and ongoing compliance obligations.
Does a subsidiary’s holding company have to be a Corporation?
No, limited liability entities may also be holding companies. Note that some states restrict ownership, prohibiting trusts from owning stock in a subsidiary. Other restrictions might also apply depending on the state’s laws.
Can a subsidiary be an S Corporation?
An S Corporation cannot be owned by a C Corporation, LLC, Partnership, or another S Corp (with a few exceptions). Therefore, under most circumstances, a parent company cannot have a subsidiary set up as an S Corporation.
Do subsidiaries file their own tax returns?
By default, a subsidiary that is a Corporation must file its own tax return. However, by filing IRS Form 1122 (Authorization and Consent of a Subsidiary Corporation to be Included in a Consolidated Income Tax Return), a subsidiary corporation may opt to be included in a consolidated income tax return filed by its parent corporation.
Because a subsidiary set up as an LLC is a pass-through entity, its profits, losses, and tax obligations flow through to the parent company and are reported on that LLC’s or Corporation’s income tax return.
In addition, some states may require LLCs to have separate filings between parent and subsidiaries for Franchise Tax or other state income tax based on gross sales or net income for doing business in said state.
What are some real-world subsidiary examples?
Many well-known corporations own subsidiaries which you may or may not be aware of. I’ve listed a handful of examples below sourced from the companies’ most recent (as of this writing) annual reports filed with the SEC. Note that the corporations mentioned have far more subsidiaries in addition to the examples I’ve shared.
Coca-Cola Subsidiary Examples Include:
- Atlantic Industries
- BA Sports Nutrition, LLC
- Energy Brands, Inc.
- European Refreshments Unlimited Company
- The Coca-Cola Export Corporation
McDonald’s Subsidiary Examples Include:
- McDonald’s Deutschland, LLC
- McDonald’s Restaurant Operations, Inc.
- McDonald’s USA, LLC
- McDonald’s Real Estate, LLP [United Kingdom]
- McDonald’s Restaurants of Canada Limited
Apple, Inc. Subsidiary Examples Include:
- Apple Insurance Company, Inc.
- Apple Korea Limited
- Apple Operations Limited
- Apple Sales International Limited
- iTunes K.K.
Ford Motor Company Subsidiary Examples Include:
- Canadian Road Leasing Company
- Ford Component Sales, LLC
- Ford European Holdings, Inc.
- Ford Holdings, LLC
- Ford Motor Company Limited
Is a Subsidiary Right for You?
That’s a question that demands some significant thought and research. I recommend that business owners talk with an experienced attorney and accountant or tax expert to explore whether a subsidiary arrangement or other approach to structuring multiple businesses will be most advantageous. When it comes to the legal, financial, and tax implications, there are no such things as being too informed or prepared.