Indirect Subsidiary Definition: Everything You Need to Know
An indirect subsidiary definition explains the relationship that exists between a parent company and its subsidiaries when the subsidiary is not wholly owned.3 min read
An indirect subsidiary definition explains the relationship that exists between a parent company and its subsidiaries when the subsidiary is not a wholly owned subsidiary.
It is not uncommon for one company to either completely or partially own shares in another company. When a company owns enough stock in another corporation or enough of a controlling interest in another entity to influence the way it conducts business, that other company is called a subsidiary. The company with the controlling interest is called the parent company. The parent company can have as many subsidiaries as it likes, whereas a subsidiary can only have one parent company. A subsidiary can be another corporation, a limited liability company (LLC), or even a partnership or sole proprietorship.
When a parent company owns more than one subsidiary, those entities are defined for tax purposes as “entities under common control.” There are two conditions for this definition to apply:
- The parent company has a controlling interest (either wholly/directly or indirectly) in all of the entities.
- The parent company has a controlling interest (either wholly/directly or indirectly) in at least one of the companies it owns, and no other company has a controlling interest in any of the companies the parent company has an interest in.
What Is a Subsidiary?
In order to be a subsidiary, another corporation must own more than 50 percent of its stock. If it’s a wholly-owned/direct subsidiary, then another company owns 100 percent of its stock. Regardless of the percentage of ownership, a subsidiary must be a separate entity and not merely a division of a company operating under a separate name.
Parent companies tend to be large corporations that have more than one subsidiary. The degree of control the parent company exerts can vary. It often depends on the level of trust the parent company has in the management team of the subsidiary. However, in the case of a wholly owned/direct subsidiary, which has no minority shareholders and stock shares are not traded publicly, the day-to-day operation of the subsidiary is likely to be managed
What Is an Indirect Subsidiary?
The significant factor in determining whether a subsidiary of a company is an indirect subsidiary is that, while the parent company does not have complete control over the subsidiary (as in the case of a wholly owned/direct subsidiary), it does have enough interest in the company to affect the operation of the subsidiary. A good example of an indirect subsidiary is what may occur in a joint venture when one of the companies in the business arrangement has more than a 50 percent interest in the new company that is formed.
Why Corporations Own Wholly Owned/Direct Subsidiaries
There are several reasons companies have wholly owned/direct subsidiaries:
- If a company wants to set up a business in a foreign country, it might be simpler to purchase an existing subsidiary than go through the often onerous procedures of creating a new subsidiary in that country. In addition, the subsidiary may have already a management team in place that is familiar with the way business is conducted in that country or already have a client base.
- A company can easily acquire subsidiaries that exist in markets where the parent company wants to do business and quickly begin operations.
- A company can create subsidiaries that will support the operations of the parent corporation without interference by outside interests.
Why Corporations Own Indirect Subsidiaries
On the surface, it would appear that the advantages of a parent company having complete control over its subsidiary, as is the case in a wholly owned/direct subsidiary, would outweigh settling for only a majority ownership in a subsidiary. However, there are occasions where it benefits a company to have an indirect subsidiary.
- A company may want to set up operations in another country, and the laws of that country prohibit the existence of wholly owned/direct subsidiaries.
- The parent company may want to have the ability to attract partners that have unique talents or experience that can benefit the operation of the subsidiary.
- The parent company may want to raise capital by offering shares in the indirect subsidiary to outside interests.
If you are planning to invest in a publicly traded company, it’s wise to take the time to understand their corporate structure to determine the role subsidiaries play in their operation.
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