Why do companies create subsidiaries?

A subsidiary company which is also known as a daughter company is a business that is owned or controlled by another company. The company that owns a subsidiary is called the parent company, parent, or the holding company. The subsidiarycould be a company, corporationor limited liability company. In certain cases, it is a government or state-owned enterprise.

A subsidiary's parent company is usually the sole owner or one of several owners. If a parent company or holding company owns 100% of another company, that company is called a "wholly-owned subsidiary."

Holding company

Companies with multiple subsidiaries that have no primary business activities of their own are also known as holding companies.

Purpose of a subsidiary

• Separation of brand identity

A company may create subsidiaries to keep its brand identities separate.

• Maintenance of goodwill

This allows each brand to maintain its goodwill that is already established with the customers and vendors.

• Opportunities for Acquisitions

Subsidiaries are often used in acquisitions where the acquiring company intends to keep the target company's name and brand.

Difference between branch and subsidiary

While a branch has no separate legal standing, a subsidiary company is a separate legal entity and has an identity that is distinct from its holding company. When branches are considered, there might be a joint or separate maintenance of accounts, whereas the subsidiaries maintain their own separate accounts.

How many subsidiaries can a company have?

As per the recent rules, a Company cannot have more than two layers of subsidiaries. In the previous years it has been noticed that variouscompanies have been practicing diversion of funds, tax evasion or money laundering.

Types of subsidiary companies

The subsidiary companies are majorly categorized into the following three categories –

• Public Limited Liability, the minimum capital requirement of which is to be fulfilled the company owners.
• Private Limited Liability, the minimum capital is obtained from the company owners.
• Co-operative Company with limited liability, in this company type, there is a minimum requirement of at least 3 partners.

Features of subsidiary companies

• A subsidiary operates as a separate and distinct establishment or business,
• Establishments are permitted to enter into contracts,
• It can sue and be sued,
• It owns assets,
• It can settle central as well as state taxes and
• It can borrow money from financial institutions or from its parent company.

Advantages of subsidiary companies

• Tax benefits

A parent company can considerably reduce tax liability through deductions allowed by the state. For parent companies that own multiple subsidiaries, the income liability from gains made by one subsidiary can often be balanced by losses in another.

• Risk reduction

The parent-subsidiary framework lessens risk because it creates a separation of legal entities. Losses incurred by a subsidiary are not transferred to the parent company. In case of bankruptcy, however, the subsidiary’s obligations might be delegated to the parent if it can be proven that the parent and subsidiary are legally or meritoriouslyone and the same.

• Increased efficiency

In some cases, creating subsidiary enables the parent company to achieve greater operational efficiency, by dividing a large company into smaller, more easily manageable companies.

• More opportunities for diversification

Smaller subsidiary companiesget various opportunities to diversify and create products or services that are superior in quality. The subsidiaries can utilize resources available to them and produce customer oriented products in an efficient manner.

Reasons companies have subsidiaries

Subsidiaries are a common type of business practice in several industries and they hold essential reasons behind their establishment.

A company plans to establishsubsidiaries to keep its brand identities separate. This allows each brand to maintain its established goodwill with customers and vendor relationships. Subsidiaries are often used in acquisitions where the acquiring company intends to keep the target company's name and customers.

A basic example of a subsidiary is that if a Company A owns Companies B, C, and D and Company D is sued, the other companies are not affected.

A parent company can create a new subsidiary from within or take over a controlling interest in an existing company. There are several reasons for a company to have subsidiaries.

In the next section we will talk about some reasons why companies create subsidiaries –

Brand recognition

A company plans and creates subsidiaries to separatethe parent company’s brand identities. This allows each brand to maintain its established goodwill with customers and vendors. Subsidiaries are often utilized in acquisitions where the acquiring company intends to keep the target company's name.

Financial considerations

The business will be in a position to save on its taxes if the parent company owns over 80 percent of one or more subsidiaries. The parent can file a consolidated tax return and utilize losses from a failing subsidiary to offset income from other subsidiaries. By keeping each company separate, the parent company can sell unprofitable subsidiaries without disrupting its own business activities. Because the assets of each subsidiary are also separate, the reach of creditors is limited to only the subsidiary that signed the contract with that particular creditor.

Raising capital

A subsidiary also permits to offer stock in a portion of the company without affecting the parent company's stock price. For example, startups often hold initial public offerings to raise funds for the company and cash out some of the founders' personal investment. This is more challenging for an established company that needs capital for a new venture. In this case, it may be better to raise capital from the subsidiary by taking that subsidiary public. Only the subsidiary that benefits from the invested capital must offer equity to outside investors.

Reporting and Disclosure issues

The parent company can decide on the areas of the business that must be public and the ones that must be private as not all business operations need to reported and disclosure requirements.

How is a subsidiary formed?

A subsidiary is formed by acquiring registration with the state in which the company operates. The ownership of the subsidiary is stated out in the registration.

Let's say Company A wants to form a subsidiary to manage its properties. The subsidiary, Company B, registers with the state and indicates that it is wholly owned by Company A.

Process of Subsidiary registration

The process of Indian Subsidiary Company Registration are following these points.

• Filing of the application form
• Acquire DSC and DIN
• Obtain name approval
• Submission of documents
• Issue of certificate

Documents required for Indian subsidiary registration

• Copy of PAN card and related details of all directors and shareholders
• Proofof Address of all directors and shareholders
• Identity Proof such as Aadhaar Card, Driving License, Voter ID of all designated directors and shareholders
• Passport and Photographs of directors and shareholders
• Directors Identification Number (DIN) of designated directors or partners
• Digital Signature Certificate(DSC) of designated directors or partners
• Memorandum of Association (MOA)and Article of Association of the Company (AOA)
• A No Objection Certificate (NOC) from the landlord who owns the property where the business is established
• Incorporation certificate that is issued by the foreign government
• Resolution from foreign company for establishing the subsidiary company in India that states the name of authorize representative
• Proof of residence, for instance, utility bills such as telephone, water, electricity bill etc as of the registered office

Conclusion

Subsidiaries are a good method and it also provides various benefits and mitigates risk and business loss. Companies that opt for subsidiary establishments turn out to be more profitable than they were initially.

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