Distinction Between Subsidiary and Wholly Owned Subsidiary

According to section 4 of the Companies Act, a company shall be deemed to be a subsidiary of another, if and only if:

(a) that other controls the compositions of its Board of directors; or

(b) that other holds more than half in nominal value of its equity share capital(where a company had preference share holders, before commencement of the Companies Act,1956, enjoying voting rights with that of equity shareholder, for the purpose of control, holding company should enjoy more than half of the total voting power) [1] ; or

(c) the first-mentioned company is a subsidiary of any company which is that other's subsidiary.

For example, where company B is a subsidiary of company A and company C is a subsidiary of company B then company C shall be the subsidiary of company A. if company D is a subsidiary of company C, then company D shall also be a subsidiary of company B and consequently also of company A. [2] 

In the case of M.Velayudhan v. Registrar of Companies [3] the position regarding holding-subsidiary relationship was extensively laid down :

“Sec. 4 envisages the existence of subsidiary companies in different situations. It may be that by acquiring sufficient share capital of a company, sufficient control may be obtained over the company to enable control in the composition of BOD. But, it is also possible to obtain such control in regard to the composition of the BOD without making such an in equity capital of the company. Such control may be by reason of an agreement such as where one company may agree to advance funds to another company and in return may, under the term of an agreement, gain control over the right to appoint all or a majority of BOD. The first of the cases envisaged in section 4 is the case where a control is obtained by a company in the matter of composition of the BOD of another company. That would be sufficient to constitute the former as holding company and the other as subsidiary. The second type of cases is where more than half of the nominal value of the equity share capital is held by another company. By virtue of such holding that other company becomes a holding company and the one whose share are so held becomes a subsidiary company. The third case envisaged is where a subsidiary company of a holding company may be a holding company in relation to another company. That other company is also a subsidiary of the holding company of the subsidiary". [4] 

So basically speaking, when a particular company A owns/ acquires more than fifty per cent of voting stock of another company B, then in such circumstances company B becomes the subsidiary of Company A, thus also obtaining the control of its operations, the company A (the acquiring company) becomes the subsidiary company’s(company B) parent company. The parent company maybe sometimes, be organized for holding of stock in other companies, such parent companies are called “holding companies". A “wholly owned subsidiary" is when the parent company owns all the voting stocks of another company. A company also may become a subsidiary through acquisition. A company may establish a subsidiary by forming a new corporation and retaining all or part of its stock.

Research Methodology

Specific object- The aim of the project is to study subsidiary and wholly owned subsidiary company and identify the difference between subsidiary and wholly owned subsidiary company.

Discussion points- The researcher would like to answer the following questions-

1. What is a Subsidiary and Wholly Owned Subsidiary?

2. What are the advantages and disadvantages of Subsidiary and Wholly Owned Subsidiary?

3. While in the process of answering the above mention questions identify the difference between them.

Hypothesis- The definition of subsidiary and wholly owned subsidiary company has been stated under sec. 4 of the Company Act. But the area of their differences and their advantages and disadvantages is somewhat unclear.

Methodology & review of literature- The trend of research undertaken by the researcher has been largely based on secondary resources and electronic sources. The researcher has used books and online resources to elaborate of the topic.

Subsidiary and Wholly Owned Subsidiary

Subsidiary Corporations

A subsidiary company is a company which is owned by a larger company or corporation. The larger company is known as the parent corporation. The parent company can own the subsidiary company by owning more than 50% of the issued share capital. Subsidiary companies should not be confused with mergers where the parent company purchases a company and dissolves its identity and organizational structure. A subsidiary company may own subsidiary companies which will consequently be subsidiaries of the parent company. For the purposes of taxation and regulation, subsidiary companies are separate legal entities. [5] 

There are two ways a subsidiary company can be formed: one is when a corporation purchases a controlling interest in an existing company. The second is where the corporation creates a subsidiary itself. When a corporation acquires an existing company, forming a subsidiary can be preferable to a merger because the parent corporation can acquire a controlling interest with a smaller investment than a merger would require. [6] And unlike in mergers, the approval of stockholders of the acquired firm is not required. When a company is purchased, the parent corporation may determine that the acquired company's name recognition in the market merits making it a subsidiary rather than merging it with the parent company. [7] A merger is not suitable if the subsidiary produces goods and services that are different to those of the parent corporation. Corporations that operate in more than one country often find it useful or necessary to create subsidiaries. [8] For example, a multinational corporation may create a subsidiary in a country to obtain favorable tax treatment, or a country may require multinational corporations to establish local subsidiaries in order to do business there. [9] 

A parent company should take the following steps in order to ensure control of a subsidiary without interfering into the matters of the subsidiary company i.e. allowing the subsidiary company to operate as an independent entity under the direction of its BOD [10] :

(1) Be the sole shareholder;

(2) Include voting control provisions in the subsidiary's articles of incorporation along with provisions that prohibit amendment of the articles without the approval of the sole shareholder;

(3) Prepare comprehensive bylaws defining the designation and authority of officers, their term of office, their removal (for cause, or for any or no reason);

(4) Include in the bylaws the procedure whereby the parent elects and removes directors; and

(5) Prohibit bylaw amendments without the sole shareholder's approval, etc.

Subsidiaries can also be created for the specific purpose of limiting their liability in connection with a new business that may be considered risky. Since the parent and subsidiary companies remain separate legal entities, they do not share in the obligations and liabilities of one another. However, it is not uncommon for the parent company to be sued if its subsidiary suffers from financial insecurity. Generally, the separate legal identities of the two companies will ensure that the parent company is immune from financial liabilities of the subsidiary, but there can be some exceptions. [11] 

Wholly-Owned Subsidiary

A ‘wholly-owned subsidiary’ is a company which has the whole of its common stock owned by another company. This means that there are no individual shareholders and that the common stock is not publicly traded. The subsidiary, being a separate legal entity, is organized as a corporation with its own structure and management. However, its day-to-day operations may be completely controlled by the parent company or the subsidiary may be allowed some independence. [12] 

Companies can derive various advantages of the structure of a wholly-owned subsidiary. In countries where the licensing environment makes it difficult to create a new company, the parent company can take control of an existing company which has the authority to conduct business there. Acquiring a subsidiary that already holds a permit simplifies the ability to conduct business without delays. [13] 

A parent company is usually a publicly-traded company. The profit or loss of all wholly-owned subsidiaries is consolidated into the parent company and the parent company releases information pertaining to all subsidiary businesses in a single annual report. Sometimes, the parent company only serves the role of a holding company to own other companies. In such a case, the parent company does not have any operations besides managing a group of wholly-owned subsidiaries. [14] 

For all the benefits that arise out of owning a subsidiary, the management of the subsidiary can be restricted by autonomy enforced by the parent company. If a private company is acquired by a public corporation, the change in management style can lead to a period of rough transition. Subsidiary management is often carried out by bringing in replacements from within the employees of the parent company. An exception is when the subsidiary management has knowledge or experience which is not readily available to the parent company. [15] 

Advantages & Disadvantages

Advantages & Disadvantages Of Subsidiary Corporations

One of the advantages to in having a subsidiary company is from the accounting perspective as there are many tax and legal benefits. It gives the ability to offset profits and losses of one part of business with another on federal tax returns and of course there are tax benefits at state and international level as subsidiaries in some states are allowed to file tax returns only on profits generated within the state area and not those profits that are generated on other locations, and the same is true for many companies that set up subsidiaries internationally. Hence the profits and losses of that subsidiary company will be taxed only according to the country they have been set up. It also provides few legal benefits, the most beneficiary is that if a subsidiary company suffers any liability, then the liabilities and credit claims won’t be passed on to the parent company, ensuring that the assets of the parent company suffer no harm even though the subsidiary is suffering financially. It also allows taking part in joint ventures with other companies, where each party owns a part of the new business.

As long as the parent company holds its subsidiary accountable for the expectations of its board of directors there is little risk for the parent to be found liable for the wrong doings of the subsidiary. But, if the parent company exercises excessive control for example has the same board of directors, use of common letterhead, in such case the parent company and the subsidiary are treated as one and the parent company is responsible for the subsidiaries debts etc. [16] 

Therefore to summarize it all:

Advantages 

Considerable tax advantages and legal protections,

Ability to offset profits and losses of one part of a business with another,

Some countries allow subsidiaries to file tax returns on the profits obtained in that country,

Liabilities and credit claims are locked in that subsidiary and cannot be passed on to the parent company,

Allows for joint ventures with other companies with each owning a portion of the new business operation.

Disadvantages 

Legal paperwork involved with creating a subsidiary can be lengthy and expensive,

Control also becomes an issue when a subsidiary is partially owned by another outside organization,

Advantages & Disadvantages Of Wholly-Owned Subsidiary

Usually, an individual cannot function as a subsidiary because a business unit functions only through its board of directors and employees. However, one can obtain control of the company by obtaining ownership of the company’s stocks, by a wholly owned subsidiary. There are many advantages of setting up a wholly owned subsidiary which include the following [17] :

“Offers security and good protection for the proprietary information, company’s trade secrets, expertise and technical knowledge, apart from offering a high degree of control over the operations. Unlike in a joint venture, in a wholly owned subsidiary, the company’s trade secrets, technological competence and administrative decisions can be well-guarded".

“Improves global strategic coordination as it offers strong control over the global operations of that subsidiary. This is particularly significant in the case of parent companies which need to completely rely on foreign managers to manage the operations of their various plants".

However, considering the huge amount of capital required it’s not always easy to set up this form of subsidiary and there is always the added fear of failure, as there are risks of making wrong decisions because it is new and unfamiliar to the type of market trends and fluctuation situation. Following two points are a major disadvantage of these types of subsidiaries [18] :

The first and foremost point to be considered while setting up a wholly owned subsidiary is the huge amount of initial investment capital. The firm will have no other option but to bear all of the establishment costs for setting up the subsidiary on foreign land and operational costs to cover the global operations of this subsidiary,

The second and most dangerous drawback is that there is the risk associated with becoming a subsidiary. This risk is the risk of failure. The situation can go out of the hand, especially if a foreign subsidiary rushes ahead recklessly without trying to get familiarized with the cultural aspects and market swings in the host country. Often, it is seen that the subsidiary comes down crashing in no time. The main cause behind the failure of a subsidiary on foreign land is the fact that a subsidiary ends up being ignorant of the host country’s market situation and fluctuating market trends. The subsidiaries often end up misjudging the host country’s market situation and make erroneous decision.

CONCLUSION

In a subsidiary the parent company gains tax and legal advantage, there is no liability for being legally responsibility for the Liabilities and credit claims of the subsidiary as it cannot be passed on to the parent company, the parent company can also form a joint ventures with other companies with each owning a portion of the new business operation as well as the ability to offset profits and losses of one part of a business with another whereas wholly owned subsidiary offers security and good protection apart from offering a high degree of control over the operations, it also improves global strategic coordination as it offers strong control over the global operations of that subsidiary.

On the other hand in a subsidiary there is the disadvantage of lengthy and expensive legal paperwork involved with creating a subsidiary and also control also becomes an issue when a subsidiary is partially owned by another outside organization whereas in a wholly owned subsidiary huge amount of initial investment capital is required, like the establishment costs & operational costs etc, and also risk of failure especially if a foreign subsidiary rushes ahead recklessly without trying to get familiarized with the cultural aspects and market swings in the host country.

Therefore looking at both the advantages and disadvantages of a subsidiary company and a wholly owned subsidiary the researcher feels that he can safely conclude that a subsidiary company is more profitable than wholly owned subsidiary.