A wholly owned subsidiary is a company in which another company, which is generally called the parent company, owns the whole shareholding. Instead of functioning as an integral division or unit of the parent company, the subsidiary typically runs independently of it, having its own senior leadership structure, products, and clientele. Nonetheless, the parent company continues to have significant control over the subsidiary’s strategic direction. In this article we’ll look at the advantages of wholly-owned subsidiary in India, factors to consider before setting up and important frequently asked questions about wholly-owned subsidiaries.
Importance of Wholly Owned Subsidiaries in India
Starting a new business can be a daunting task. Incorporating a wholly-owned company is advantageous because while it allows the parent business to control the decision-making of the wholly-owned company without having to inherit its losses. The provision of forming a wholly owned subsidiary allows the opportunity for coordination of global corporate strategy. This makes a wholly owned subsidiary a very important centerpiece in the primary considerations for businesses to expand globally.
Advantages of Wholly Owned Subsidiaries
The financial, operational, and strategic advantages of wholly-owned subsidiaries are as follows:
1. Reduces Costs
The subsidiary’s costs are reduced because the parent business handles all crucial overhauls. There may also be a mutual agreement between the parent company and the wholly-owned subsidiary in which both parties profit from pooled resources. This reduces the cost of procuring new technology and making changes in the financial systems as the parent company will already use its resources to understand the changes in the financial systems.
2. Tax Benefits
It assists the parent entity in significantly reducing its tax liability by utilizing state-allowed deductions. When a parent business has many subsidiaries, the profits from one of them can be used to offset the losses from the other firm.
3. Risk reduction via a Subsidiary
The risks associated with the business are reduced because it is a separate and distinct legal entity from the parent company. Additionally, the losses incurred by a wholly-owned subsidiary are not transferred to the parent company.
4. Simple reporting
The reporting method of a wholly-owned subsidiary is generally simple. In most cases, the parent company is in charge of consolidating all of the subsidiaries’ financial statements. Therefore, the subsidiary is not accountable for generating distinct financial statements. Additionally, when the parent entity combines all the financial statements into one, the subsidiary receives several forms of aid.
5. Enhanced efficiency and diversification
The parent company may improve effectiveness by dividing a big corporation into smaller, better-managed ones by creating subsidiaries.
Factors to Consider Before Setting Up a Wholly Owned Subsidiary in India
1. Minimum Costs and Capital Requirement
Every country has laws laying down minimum thresholds that may be required for incorporating a company. There are several filings and documentation that have to be undertaken before incorporating a company and a minimum number of shareholders. Therefore, prior to incorporating a wholly owned subsidiary, a parent company should consider if there is enough in the company coffers to meet the minimum capital requirement.
2. Objective for Wholly-owned Subsidiary
It is essential that the board of directors of the parent company identify the purpose of the wholly owned subsidiary. Most jurisdictions have laws prohibiting the parent companies from setting up wholly owned subsidiaries as shell companies. Therefore, having a defined objective for the incorporation of a wholly owned subsidiary must be shown by way of the documents of incorporation.
3. Legal and Accounting
Establishing a wholly-owned subsidiary also means increased legal and accounting compliance. For instance, for every litigation that is initiated against the wholly owned subsidiary, the parent company will also be made a party. Therefore, litigation against the parent company will inevitably increase substantially by establishing a wholly-owned subsidiary.
4. Human Resources
The parent company must consider staffing the wholly-owned subsidiary with the right potential by creating a comfortable workspace for the wholly-owned subsidiary’s employees as well. The management of the parent company may have to map out a strategy to execute HR, insurance, benefits, payroll and risk management, and administrative operations. There may also be a requirement for devising a plan to ensure proper employee training is conducted in a well-set-up office infrastructure. The wholly-owned subsidiary will have to ensure mandatory compliance with the laws, monthly payroll execution, taxation compliances, accounting, employee benefits, bookkeeping, coordination with auditors, etc.
5. Market Dynamics
Market dynamics like demand and supply are influenced by phenomena like pandemics or wars. Therefore, before establishing a wholly owned company, the parent company (whether domestic or foreign) should consider the market dynamics. For instance: A recession may severely affect the ability of a company to invest in a wholly-owned subsidiary; and therefore, the parent company must consider these factors before establishing a wholly-owned subsidiary.
To their advantage, large corporations buy smaller companies and turn them into wholly-owned subsidiaries. This enables the parent company to grow without worrying about spending money to create a new environment from the start. The parent company finds it much simpler to move forward with business development because the workforce, corporate procedures, and revenue model are already in place.
Frequently asked questions
1. What is the difference between a holding company and a wholly-owned subsidiary?
The holding company only holds the stocks of a company in someone else’s control. However, the parent company owns all the stocks and operations of its wholly-owned subsidiaries. For example, the parent company Pepsi has various subsidiaries across the globe.
2. What are sister companies?
Subsidiaries related to one another on the grounds of a common parent company are sister companies.
3. What is the disadvantage of setting up a wholly-owned subsidiary?
Once a company becomes a large organization’s subsidiary, they have less freedom to make decisions. Also, when a subsidiary company raises an issue, it must go through several steps before the parent company takes action.
4. What are the tax benefits of a wholly-owned subsidiary?
When a company has multiple subsidiaries, it can use the loss of one company to balance with the profits of others. This helps them to manage the overall tax liabilities.