A subsidiary is a company that is controlled or owned by another company – the parent company or holding company. The parent company owns at least 50% of the commercial enterprise’s voting stock; it has a controlling interest.
The subsidiary may be a limited liability company, a corporation, or a state-owned enterprise.
When the holding company owns a business entity abroad, that subsidiary has to follow the laws of where it operates and is incorporated.
Berkshire Hathaway Inc., an American multinational conglomerate holding company, has several subsidiaries – companies in which it owns over 50% of the voting shares.
According to BusinessDictionary.com, a subsidiary is:
“An enterprise controlled by another (called the parent) through the ownership of greater than 50 percent of its voting stock.”
Etymologists (they study the origin of words) say that the word ‘subsidiary’ comes from the Latin subsidiarius meaning ‘reserved, of a reserve, belonging to a reserve; supplement, or serving to assist’. Subsidiarius came from Subsidium, meaning ‘a help, troops in reserve, aid’. As a noun with its modern meaning in the English language, ‘subsidiary’ appeared in Britain during the 1600s.
In the United States, an operating subsidiary is a commercial enterprise that operates with its own identity, while a non-operating subsidiary uses the identity of the holding company.
Subsidiary also means ‘secondary’, as in this statement by the 14th Dalai Lama: “Religion does not mean just precepts, a temple, monastery, or other external signs, for these as well as hearing and thinking are subsidiary factors in taming the mind. When the mind becomes the practices, one is a practitioner of religion, and when the mind does not become the practices one is not.” (Image: Wikipedia)
In the world of business, subsidiaries are extremely common. Virtually every multinational corporation organizes its operations with subsidiaries.
For example, Berkshire Hathaway, based in Omaha, Nebraska, wholly owns NetJets, FlightSafety International, Helzberg Diamonds, Fruit of the Loom, Dairy Queen, Lubrizol, BNSF and GEICO, and has significant minority holdings in the Kraft Heinz Company, American Express, and several others.
Subsidiary is a separate legal entity
As far as taxation, regulation and liability are concerned, a subsidiary is a separate, distinct legal entity, unlike a division, which is a business that is fully integrated within the main company.
Subsidiaries can be sued or sue separately from their parent companies, and their obligations will not usually be the obligations of their holding companies.
This separate legal structure is commonly used by large companies to gain certain tax benefits, monitor the results of a distinct business unit, isolate risk from the rest of the corporation, or prepare for the sale of certain assets.
Lawyers can sometimes go to court and make the parent company liable when a subsidiary becomes insolvent if they are able to pierce the corporate veil and show that the parent and subsidiary are no more than alter egos of each other, therefore any patents, trademarks and copyrights remain with the subsidiary until the holding company shuts it down.
Subsidiary vs. Affiliate
An affiliate or associate is a company whose parent only owns a minority stake.
Holding companies own more than fifty percent of subsidiaries, thus giving them control of the commercial enterprise.
For example, Berkshire Hathaway wholly owns Fruit of the Loom, Dairy Queen and NetJet – so they are subsidiaries. However, American Express, the Kraft Heinz Company, IBM and Wells Fargo are affiliates, because it has significant minority holdings in them.
In the United States, for the holding company to submit consolidated tax returns it must own at least 80% of the subsidiary.
Banks and multinational corporations use a strategy known as foreign direct investment. They create subsidiaries or affiliates to break into a target market which they would find much more difficult if they used their main name.
Subsidiaries might be established from day one – at the outset of a commercial enterprise’s formation – or acquired further down the road by buying controlling interests.
Benefits of establishing subsidiaries
– The subsidiary benefits from the holding company’s financial resources and name recognition.
– For employees, there may be promotional and cross-training opportunities that would not have been available before the new affiliation.
– The holding company does not require shareholders’ approval to move forward with establishing subsidiaries, unlike mergers.
– Establishing a subsidiary is considerably cheaper than a merger.
– Globally, forming or acquiring subsidiaries overseas generates goodwill in markets that might not otherwise be amenable for doing business, and offers tax advantages.
Video – Accounting for Subsidiaries
In this video, Dr. Dave Bond gives us an overview of the key elements of the initial investment by a holding company in a subsidiary.