Definition of a Subsidiary

A corporation may establish a subsidiary by purchasing another company or, at the very least, becoming the majority shareholder in that other company. It is also possible for a parent firm to initiate the formation of a subsidiary.

The parent-subsidiary relationship is the relationship between a parent and a subsidiary. This type of relationship allows the parent to own a controlling stake in the capital or stock of the subsidiary. This allows the parent company to control the subsidiary's activities. It can decide its business strategy, appoint its board of directors, and provide executive leadership.

Berkshire Hathaway is an international conglomerate that Warren Buffett manages. It is one of the most well-known examples of a holding company. Berkshire Hathaway has several businesses, including GEICO, Fruit of the Loom, and Dairy Queen. Buffett's corporation also holds non-controlling stakes at companies such as Apple, Coca-Cola, and Bank of America.

The Functioning of a Subsidiary

It is essential to remember that having a subsidiary is not the same as participating in a merger deal. When two companies merge into one, the assets of the business being acquired are taken over by the company being acquired, and the company being acquired ceases to exist as a distinct entity. Contrary to the purchase of a controlling share of a firm, which does not need the agreement of the stakeholders of the acquired company, a merger must.

A firm may also purchase a controlling part of another company and make it a subsidiary with less cash than it may require to merge with another company. This is an alternative to the traditional method of merging with another company. Or it may carry out a "short-form merger" with a subsidiary in which it has at least 90% of the ownership and assumes full control of the unit, often without the requirement for permission from the company's shareholders.

A parent firm can have a subsidiary involved in entirely other markets. Additionally, subsidiaries often function as separate legal entities from their parent companies while doing business. For instance, Dairy Queen and GEICO, both fully owned subsidiaries of Berkshire Hathaway, cater to quite distinct requirements that their respective customers have.

In other circumstances, a subsidiary's goods or services may have a strong connection to its parent firm. Both Google and YouTube are examples of online platforms that rely heavily on advertising income for most of their financial success. Both Google and YouTube are completely owned subsidiaries of Alphabet.

Concerning Financial Reporting and Taxation With Subsidiaries

Corporations can file consolidated federal tax returns for numerous related firms. These companies must have a parent company and at least one subsidiary, and the parent company must control at least 80% of the shares in each subsidiary. The net loss of one firm might be offset by the net profit of another company in the group, which is one reason this could be done.

Many firms set up subsidiaries in other countries; in certain cases, this is required by the government of the nation where the subsidiary is being founded. It is also typical practice for major corporations based in the United States to create subsidiaries in other countries to take advantage of the lower tax rates. Soon after being elected president, Joe Biden made public his intention to impose a tax penalty on corporations that create goods and services outside the United States but sell those products or services inside the United States.

Pros

Reduces the dangers faced by the parent firm

Some of the subsidiaries are new ventures or very young businesses with a shorter history of operations. When a subsidiary fails, the parent company is often not held accountable for the debt incurred by the subsidiary. The subsidiary is structured as a distinct entity from the parent firm.

Potential tax advantages

A great number of subsidiaries are located in other countries that have lower tax rates. When a parent business consolidates its tax reporting, it can balance the earnings of one firm within the group of companies against the loss of another company within the group.

Cons

Can be found to be accountable for

There have been cases in which parent businesses have been found responsible for subsidiary firms' debts or unfavorable judicial judgments against such companies.

Reporting financial transactions and taxes may be complicated

Put another way, having more firms in a group will result in more assets, debts, and tax obligations.