What is a Subsidiary?
A subsidiary is a company that is controlled and owned to a significant extent by another company. The company that controls the subsidiary is called the parent company or sometimes a holding company.
How Does a Subsidiary Work?
Subsidiaries are common in certain industries, especially in real estate. A company that owns properties and holds several assets containing rental apartments might form a public holding company, where each property is a subsidiary. The reason for this is to protect the assets of different properties from mutual liabilities. For example, if Company A owns Companies B, C, and D (each being a property) and Company D is sued, the other companies cannot be held liable for the actions of Company D.
A subsidiary is formed by registering in the state where the company operates. The ownership of the subsidiary and its legal entity type – such as a limited liability company – are determined in the registration process.
Let’s assume Company A wants to form a subsidiary to manage its properties. The subsidiary, Company B LLC, registers in the state and indicates that it is entirely owned by Company A.
How are Subsidiaries Accounted For?
From an accounting perspective, a subsidiary is considered a separate entity, so it maintains its financial records and bank accounts and tracks its assets and liabilities. Any transactions between the parent company and the subsidiary must be recorded.
The subsidiary may also be a separate entity for tax purposes. Each subsidiary has its own Employer Identification Number and may file its own taxes, depending on its business activities.
However, many public companies present consolidated financial statements, including balance sheets and income statements, that show the parent company and all subsidiaries combined. If the parent company owns 80% or more of the stock and voting rights in the subsidiaries, it can file a consolidated income tax return that may benefit from offsetting the profits of one subsidiary with losses from another. Each subsidiary must agree to be included in this consolidated tax return by filing IRS Form 1122.
Due to the complex nature of accounting and taxation for parent and subsidiary companies, business owners should consider hiring accounting and legal professionals to help them navigate the laws and regulations.
Holding Company vs. Parent Company
The primary purpose of holding companies is often to retain ownership of subsidiaries. If this is the case, the company is referred to as a “pure” holding company. If it also conducts business on its own, it is referred to as a “mixed” holding company. An example of a pure holding company is Alphabet Inc., which is publicly traded and aims to retain Google and other less well-known subsidiaries like Calico and Life Sciences. YouTube, in turn, is a subsidiary of Google.
The parent company operates its own businesses in addition to the subsidiaries that run their own operations. An example of this is Facebook Inc.: Instagram LLC, Oculus VR LLC, and WhatsApp Inc. all became subsidiaries of Facebook Inc. after being acquired by Facebook.
Subsidiary vs. Affiliate or Associated Company
If a company owns 50% or less of another company – and thus does not control it – the partially owned company is referred to as an “affiliate” or “associated company.”
It is noteworthy that in affiliate marketing, one company is paid when it brings traffic to another company’s website, and the customer purchases a product. In this type of relationship, neither company has an ownership stake in the other.
Subsidiary
Subsidiary vs. Branch or Division
You may have seen the terms “branch” or “division” used as synonyms for the term “subsidiary,” but they are not the same thing. A subsidiary is a separate legal entity, while a branch or division is a part of the company that is not considered a separate entity.
A branch is generally defined as a separate location within the company, such as a Pittsburgh branch of a company headquartered in New York. A division is a part of the company that engages in a specific activity, such as the wealth management division of a larger financial services company.
Key Takeaways
– A subsidiary is controlled and owned to a significant extent by a parent or holding company.
– A subsidiary can be formed as different types of legal entities.
– A subsidiary produces its own financial statements and may file its own income tax return. However, public companies owning 80% or more of subsidiaries can file consolidated tax returns that allow them to offset profits of some subsidiaries with losses of others.
– A holding company typically does not engage in its own business, while a parent company has core businesses that differ from those of its subsidiaries.
Source: https://www.thebalancemoney.com/what-is-a-subsidiary-company-4098839
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