When a subsidiary company is held by a parent company, its controlling interest is in the hands of the parent company. In other words, for it to be a subsidiary company, more than 50% of its stock must be owned by the parent company. There are instances where 100% of the stocks are held by the parent company. Such subsidiaries are called wholly or fully owned subsidiaries. Parent companies form or buy subsidiaries with various intentions such as earning tax benefits, diversifying business risks, or strengthening their asset base by owning more equipment, supplemented earnings, or property.
Nevertheless, subsidiaries are legally considered separate entities. They operate and account separately for aspects like taxation, liabilities as well as governance. When a subsidiary is established in another country, it must abide by the laws and regulations of the country in which it is established and operated. Taking advantage of their controlling interests, parent companies often interfere in matters pertaining to subsidiaries. For example, the board of directors of a subsidiary often consists of many board members of the parent company. When purchasing a subsidiary company, the procedure is different than that of a merger. Shareholdersâ€™ approval is not required in doing so and the investment to be made is smaller. Even in an instance of selling off a subsidiary, shareholder votes are not required. To be classified as a subsidiary, over 50% of the stocks must be under the control of the parent company. If the percentage of controlling interest is lower than that, it is called an associate or affiliate company. Financial reporting for an associate company is very different from that of a subsidiary.
Advantages of subsidiary companies
Contained or limited losses â€“ Since the financial statements of subsidiary companies are consolidated with that of the parent company, the magnitude of any losses that may arise are negated.
Tax advantages can be obtained â€“ As the finances are presented as a whole, it helps in earning tax benefits such as tax holidays and lower tax rates.
The ease of establishing and selling â€“ Subsidiaries are very easy to establish since neither the majority vote of the board nor a huge investment are required.
Synergetic effect â€“ Since a subsidiary is operated in sync with its parent company, the advantages of such synergies can revolve around major business functions like sourcing requirements.
Disadvantages of subsidiary companies
Additional work relating to financial and legal aspects â€“ There is additional legal work in establishing, operating, and concluding business operations. Further, financial statements must be prepared according to specific formats and requirements.
High level of bureaucracy â€“ There might be a high level of interference from the parent company into the affairs of its subsidiary. This might impede the core focus of the subsidiary company.
Increased complexity in financial statements â€“ As the financial statements are presented in an aggregated manner, they will be more complex.
The parent companyâ€™s liability in aspects of the subsidiary â€“ The parent company shall be held responsible for any adverse actions facilitated by the subsidiary company. For example, corporate crimes committed by a subsidiary company may leave an impact on the operations of its parent company.
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