A subsidiary is a business that has been established by a parent company, usually for a specific purpose. Sometimes a subsidiary is created when a parent company decides to focus on one line of business and wants to keep another line of business under management. Other times a company might wish to acquire a new business without having to manage it, or a subsidiary may be formed for any number of reasons.
Diversification
Subsidiaries can allow companies to diversify their product lines, influence, and assets. They can also expand their operations to foreign markets, since different countries have their own laws that apply differently to businesses in different locations.
Expansion
Many foreign companies have subsidiaries that operate in several countries. This allows them to comply with location-specific regulations and avoid having to pay taxes on their profits in each country.
Loss management
Subsidiaries can be used to offset losses incurred by a parent company, which is an advantage in filing consolidated tax returns. For example, a parent company that owns eighty percent or more of a subsidiary can include losses from its subsidiary on the consolidated return, which reduces total tax liability.
Limited control
A disadvantage of a subsidiary is the fact that it can only make decisions through a chain of command within the parent organization. This is the main difference between a holding and subsidiary company. This can cause significant problems if a company needs to make important decisions about products, finances, or other matters.
Increased paperwork
A subsidiary structure adds a considerable amount of paperwork to the parent company’s books and records, including financial statements for the subsidiaries and a consolidated tax return (CTR). When there are multiple subsidiaries, it can become even more cumbersome to keep track of all the financial information.
Conflicting Interest Between Parent and Subsidiary
A major disadvantage of a subsidiary is the conflict that can arise when one company has a conflicting interest with the other. This can lead to legal disputes, which can be costly for both companies.
In addition, a subsidiary might have its own CEO or president who is not necessarily part of the parent company’s management team. This can create issues with management, which might slow down or derail business efforts. Alternatively, a subsidiary might be the subject of a merger that takes control away from the parent company’s management team. The parent company would lose its majority controlling interest in the subsidiary and its board of directors could be replaced.
The parent company might then be able to exercise control over the subsidiary’s finances and other operations. This can be especially useful for a public company with a large number of shareholders. Lastly, a subsidiary may be subject to bankruptcy, which can result in the loss of its parent company’s ownership. In this case, a trustee appointed by the bankruptcy court will oversee the subsidiary’s activities and attempt to sell or liquidate it as quickly as possible.