Subsidiary Company, Types, Structure, Work, Legal Requirements

Subsidiary Company is an entity that is controlled by another company, known as the holding company. Control is generally established when the holding company owns more than 50% of the subsidiary’s equity share capital or has the power to appoint or remove a majority of its directors. This control can be direct or indirect, including through another subsidiary (step-down subsidiary). The relationship allows the holding company to influence key decisions and policies of the subsidiary without necessarily being involved in its daily operations.

Under the Companies Act, 2013 (Section 2(87)), subsidiaries are subject to specific legal requirements relating to structure, reporting, and compliance. A company cannot have more than two layers of subsidiaries, except in certain permitted cases, such as foreign subsidiaries with overseas holdings. Subsidiaries must prepare their own financial statements, which are then consolidated into the holding company’s accounts. This structure is widely used for business expansion, risk segregation, and managing diverse operations under a single corporate group.

Types of Subsidiary Company

1. Partly Owned

The parent company owns 50% or more but less than 100% shares in the holding company. Such a subsidiary is partly owned. Here parent company does not get full control over the subsidiary company.

2. Wholly Owned

The parent company holds 100% shares & controls in the subsidiary company. Though, A wholly-owned subsidiary company is not a merger.

A holding company can have more than one subsidiary company. But a subsidiary company can have one and only one holding company. However, a subsidiary can have a subsidiary or more of its own.

The parent company can be larger or smaller than the subsidiary. It need not be more powerful than the subsidiary. The size of the firm or employees does not decide the relationship. The only control over ownership is the key factor.

Also, the location or type of business of both companies does not matter.  They may or may not be in the same location or same business line.

Structure of Subsidiary Company

1. Formation

The parent company has to register with the state registrar of the state in which the company operates. The ownership & stake details are to be defined during this process.

2. Operation

Normally, the parent company just oversees the operations of the subsidiary company. However, in certain cases, the parent company may supervise day to day operations of a subsidiary company.

Subsidiaries are separate legal entities. They have their own concerns regarding the handling of taxation, regulations & liabilities. Subsidiary companies can sue & be sued separate from the parent company. the obligations of a subsidiary may or may not be obligations of the parent company. One of these companies can be undergoing legal proceedings, bankruptcy, tax delinquency or be under investigation without affecting other companies directly. though affecting public image is altogether an intangible thing.

How Does a Subsidiary Work?

Subsidiaries are common in some industries, particularly real estate. A company that owns real estate and has several properties with apartments for rent may form an overall holding company, with each property as a subsidiary. The rationale for doing this is to protect the assets of the various properties from each other’s liabilities. For example, if Company A owns Companies B, C, and D (each a property) and Company D is sued, the other companies can not be held liable for the actions of Company D.

A subsidiary is formed by registering with the state in which the company operates. The ownership of the subsidiary and the type of corporate entity such as a limited liability company (LLC) are spelled out in the registration.

How Are Subsidiaries Accounted For?

From an accounting standpoint, a subsidiary is a separate company, so it keeps its own financial records and bank accounts and track its assets and liabilities. Any transactions between the parent company and the subsidiary must be recorded.

A subsidiary may also be its own separate entity for taxation purposes. Each subsidiary has its own employer identification number and may pay its own taxes, according to its business type.

However, many public companies file consolidated financial statements, including the balance sheet and income statement, showing the parent and all subsidiaries combined. And if a parent company owns 80% or more of shares and voting rights for its subsidiaries, it can submit a consolidated income tax return that can take advantage of offsetting the profits of one subsidiary with losses from another. Each subsidiary must consent to being included in this consolidated tax return by filing IRS Form 1122.

Holding Company vs. Parent Company

Most holding companies’ sole purpose is to hold ownership of subsidiaries. If that’s the case, the company is referred to as a “pure” holding company. If it also conducts business operations of its own, it’s called a “mixed holding company.5 One example of a pure holding company is publicly traded Alphabet Inc., whose purpose is to hold Google and other, lesser-known subsidiaries like Calico and Life Sciences.6 YouTube is, in turn, a subsidiary of Google.

Subsidiary vs. Branch or Division

You may have seen the terms “branch” or “division” used as synonyms for “subsidiary,” but they are not one and the same. A subsidiary is a separate legal entity, while a branch or division is a part of a company that is not considered to be a separate entity.

A branch is usually defined as a separate location within the company, like the Pittsburgh branch of a company whose headquarters is in New York. A division is part of a company that performs a specific activity, such as the wealth management division of a larger financial services company.

Subsidiary Companies Legal Requirements under Companies Act, 2013:

• Definition (Section 2(87))

A subsidiary company is one in which another company (holding company) controls more than 50% of the total share capital or has the right to control the composition of its board of directors. This control may be direct or through another subsidiary. The definition also includes step-down subsidiaries. The Companies (Restriction on Number of Layers) Rules, 2017 limit the number of subsidiary layers, ensuring transparency. This definition is crucial for determining compliance obligations, reporting requirements, and corporate governance rules applicable to both the holding and subsidiary.

• Restriction on Layers

Under the Companies (Restriction on Number of Layers) Rules, 2017, a company cannot have more than two layers of subsidiaries. This restriction is aimed at preventing complex corporate structures that could hide ownership and financial transactions. Exceptions are allowed if the subsidiary is a foreign company with subsidiaries outside India. The rule promotes corporate transparency, facilitates regulatory oversight, and ensures that ownership structures remain simple, making it easier for stakeholders and regulators to trace control and financial relationships within the corporate group.

• Financial Statement Requirements (Section 129)

A subsidiary must prepare its own standalone financial statements as per Schedule III and applicable accounting standards. The holding company is required to consolidate these statements into consolidated financial statements (CFS). This ensures a complete financial picture of the group as a whole. The subsidiary must share its financial data promptly with the holding company for consolidation. The board of the holding company is responsible for ensuring accuracy and compliance with Indian Accounting Standards (Ind AS) or other applicable accounting rules.

• Disclosure in Board’s Report

A subsidiary’s performance, major decisions, and overall contribution to the group must be disclosed in the holding company’s Board’s Report. This includes financial highlights, operations, and any significant events affecting the subsidiary. Such disclosures enable shareholders and investors to assess the subsidiary’s role and performance within the group structure. The requirement improves transparency, accountability, and trust among stakeholders by giving them access to vital subsidiary-related information as part of the holding company’s annual reporting obligations under the Companies Act, 2013.

• Audit Requirements

Every subsidiary company must get its financial statements audited annually by a statutory auditor appointed under the provisions of the Companies Act. The audit ensures the accuracy, fairness, and compliance of accounts with legal and accounting standards. The audited financials are then shared with the holding company for consolidation. For certain classes of companies, internal audit may also be mandatory. The audit process enhances stakeholder confidence, ensures regulatory compliance, and safeguards against financial irregularities within the subsidiary company’s operations.

• Related Party Transactions (Section 188)

Transactions between a holding company and its subsidiary are considered related party transactions. These include the sale or purchase of goods, services, property, or any other arrangements. Such transactions require prior board approval, and in some cases, shareholders’ approval, especially if they exceed prescribed limits. The purpose is to prevent conflict of interest and ensure fairness in dealings between related entities. Proper disclosure of these transactions in financial statements is mandatory to promote transparency and protect minority shareholders’ interests.