subsidiary
subsidiary, a company that is at least 51 percent owned by another business firm, known as a parent company or holding company. A parent company is generally understood to be one that conducts its own business operations apart from those of its subsidiary or subsidiaries, while a holding company is one whose sole function is that of ownership. By virtue of its majority ownership of its subsidiaries’ voting stock, a parent company typically controls the membership of the subsidiaries’ boards of directors.
In the context of large corporate structures, a distinction is made between subsidiaries based on their level in an ownership hierarchy. A “second-tier subsidiary,” for instance, is a subsidiary of a “first-tier subsidiary,” which is in turn a subsidiary of the ultimate holding company, which has no parent.
Subsidiaries may provide parent companies with a number of advantages, such as tax benefits, enhanced efficiency, greater diversification, and risk reduction as well as brand growth and recognition. It is also generally easier to create or acquire a subsidiary than it is to purchase or merge with another company. Subsidiaries can minimize the parent company’s redundancies in overhead expenses and decrease its operating costs through economies of scale while fueling expansion beyond the company’s geographic region without the need to implement a new business structure.
On the other hand, subsidiaries can entail legal costs associated with paperwork as well as further investments and more demanding accounting work. There could also be disadvantages for parent companies stemming from their limited control of subsidiaries that are partly owned by other companies at the same time. Moreover, unlike a parent company, subsidiaries typically pay federal taxes on their total income rather than only on their profits. Another drawback is the possibility of double taxation—as would occur, for instance, if both a parent company and its subsidiary were required to pay taxes on the subsidiary’s profits. In 1990 the Council of the European Communities issued a directive designed to prevent such double taxation. More recently, in 2003, the Council of the European Union amended the 1990 directive to eliminate double taxation of profits in the case of subsidiaries of subsidiaries—that is, second-tier subsidiaries.
As far as accounting is concerned, subsidiaries are entitled to produce their own financial statements, thereby tracking their assets and liabilities. They have their own taxation numbers for federal purposes and pay their own taxes, though transactions between them and their parent companies need to be stated in financial records. The U.S. Securities and Exchange Commission (SEC), however, advises that public companies consolidate their subsidiaries’ financial statements with their own financial records to produce more comprehensive balance sheets and income statements. Such consolidation affords a more accurate and complete picture of the company’s financial state of affairs.
When a parent company owns at least 80 percent of the shares of two or more subsidiaries, consolidated income tax returns allow the profits of one subsidiary to be offset by losses of another. In challenging situations, such as bankruptcy, the bankrupt subsidiary should be unconsolidated, according to the SEC, meaning that its financials would not appear on the statements of the parent company. In such cases, the subsidiary would be considered an equity investment in which the parent company has a small stake.
A subsidiary differs from a division, which is not a separate legal entity as far as liability, regulation, and taxation are concerned. A division must use the same name as the parent company. A subsidiary must not be confused with an affiliate either, which is less than 50 percent owned by the parent company.