Holding Company Law: Everything You Need To Know
Holding company law governs a corporation or other business entity formed only to hold stock shares in other businesses.3 min read
2. Structure of a Holding Company
3. Public Utility Holding Company Act
4. Criticism of Holding Companies
Holding company law governs a corporation or other business entity formed only to hold stock shares in other businesses. Often, these shares are used to control administration and management of the associated companies by creating a majority interest. Most holding companies do not produce or sell their own goods or services.
The largest holding company in the U.S., Berkshire Hathaway, is owned by Warren Buffett. It owns stock in diverse industries including insurance, retail, manufacturing, and real estate. Holding company law comprises federal antitrust regulations to ensure that a corporation of this kind does not reduce competition and create a monopoly.
Benefits of Holding Companies
- Holding companies reduce risk for the companies whose stock they hold by stabilizing the investment, making it more valuable. This attracts more buyers.
- The holding company can own and control several companies, thus spreading its risk across markets and industries.
- Risk management is enhanced by dividing assets across two or more companies. This allows liability to be limited to a single subsidiary, if it gets sued for example.
- Subsidiaries that are completely owned by a holding company can be treated as pass-through tax entities. This eliminates the need to file a corporate tax return while maintaining limited liability.
- A product line can be sold or transferred easily and confidentially, without revealing trade secrets.
- Intellectual property (IP) can be licensed to several subsidiaries for various purposes.
Structure of a Holding Company
A simple holding company owns all the stock shares of at least one subsidiary. The shares of the holding company are owned by trusts or individuals. The holding company and subsidiaries each act as independent entities, with separate finances and bank accounts. They must enter into agreements with one another for assets and real estate. Often, one subsidiary serves to manage the holding company's operations.
The Internal Revenue Code defines a personal holding company under two classification systems, which must be fulfilled to constitute this entity. These include:
- Personal Holding Company Income Test: The entity must possess at 60 percent or more of the adjusted ordinary gross income of the corporation in question for the associated tax year.
- Stock Ownership Requirement: At least 50 percent of the outstanding stock of the corporation must be owned by fewer than six individuals at any point during the second half of the associated tax year.
A public utility holding company owns companies that distribute gas or electricity to home and business owners. The law governing this type of holding company is the Public Utility Holding Company Act (PUHCA) of 1935, which requires utility companies to operate only in a single state or in a limited geographic region.
Bank holding companies are governed by the Federal Deposit Insurance Corporation (FDIC). These laws indicate that a bank holding company must:
- Control, own, or have voting power over at least 25 percent of a financial institution
- Control the election of a majority of directors on the company's board
- Possess a controlling influence over the organization's policies
Public Utility Holding Company Act
This law prevents companies that hold public utilities from using their profits to pay for unregulated business activities. Side endeavors must be separated from the holding company. Although some utility companies argue that PUHCA restricts competition and no longer applies, repealing this law would result in the creation of several large utility companies and eliminate industry competition. Many believe that reform of this law should only take place as part of a thorough restructuring.
This law was originally passed to counteract the unfair business practices of large utility holding companies in the 1920s and 1930s. These businesses created complex pyramid structures that held shares in many subsidiaries. For example, at one point three holding companies controlled most of the industry with more than 130 subsidiaries. This resulted in inflated rates, hidden charges and fees, and a lack of accountability.
Criticism of Holding Companies
Holding companies are often criticized because of their potential ability to monopolize a market sector. As a result, the federal government can block acquisitions and business models that deter competition, as well as majority acquisitions and mergers. For example, a repeal of PUHCA could result in massive corporations beyond the reach of federal and state regulation.
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