Corporate Law
What is a Subsidiary?
Author
Neil Williamson
Author
Neil Williamson
May 28, 2024
Corporate Law
A subsidiary is a company that is under the control of another company called a holding company.
Under section 1159 of the Companies Act 2006, a company is the subsidiary of another company (its holding company) if the holding company either:
- holds a majority of the voting rights in the subsidiary;
- is a shareholder of the subsidiary and has the right to appoint or remove a majority of its board of directors; or
- is a shareholder of the subsidiary and controls alone, under any agreement with other members, a majority of the voting rights.
Somewhat confusingly, section 1162 of the Companies Act 2006 contains separate definitions of a “subsidiary undertaking” and “parent undertaking”. These include similar tests to those in section 1159 but add to them by:
- including an additional test where a company is a parent undertaking of a subsidiary undertaking if it has the right to exercise “dominant influence” over the subsidiary undertaking by virtue of provisions contained in the subsidiary undertaking’s articles of association or a control contract; or
- including a provision whereby a company would be deemed to be a subsidiary undertaking of a parent undertaking if the shares in the subsidiary are held by a person acting on behalf of the parent undertaking.
Why does the Companies Act 2006 have separate definitions for “subsidiary” and “subsidiary undertaking”?
A “subsidiary” will always be a “subsidiary undertaking” while a “subsidiary undertaking” may not necessarily be a “subsidiary”. This is because the definition of “subsidiary undertaking” is wider than the definition of “subsidiary”. Generally, the Act does not feel the need to impose rules on group companies that fall outside the narrower definitions under section 1159. However, there are some occasions where it does. We see the definition of “subsidiary undertaking” appear in the Companies Act 2006 in e.g.:
- Section 215 which deals with payments to directors for loss of office “in connection with the management of the affairs of any subsidiary undertaking of the company” (as well as loss of office in the company itself). It makes sense that the Companies Act would want the definition of what would be covered by loss of office to be as wide as possible given that shareholder consent is needed to approve the payments – payments to directors are very much scrutinised in other words.
- Section 344 which deals with the appointment of an independent assessor who may not be appointed to the role of they are an officer or employee of a “subsidiary undertaking”. Again, one can understand why the wider definition was used when dealing with the appointment of someone who needs to be independent from a company.
- In Chapter 4 (Accounts) the term “subsidiary undertaking” is widely used so that, if relevant, a wider pool of financial information is included in group accounts than would be the case if the definition of “subsidiary” were used.
Why set up a subsidiary?
There are lots of reasons why it may be in your interests to set up a subsidiary. Here are some of them:
1. Shielding assets
If your US subsidiary supplies software to US customers and there’s a problem with the delivery of that software, any fallout will only hit the US entity rather than the UK parent. This is because the US entity, being a company, will have limited liability. The UK parent (or a company above it) holds the IP in the software so the group’s major asset is protected from the US claims thanks to the group structure.
A group structure is not impenetrable and care must also be taken to avoid any notion that the subsidiary is acting as an agent of its holding company. But on the whole it’s a good way to shield assets and ringfence liabilities.
2. Tax benefits
A group of companies can benefit from tax exemptions and reliefs as well as pass dividends up to holding companies tax free and move cash around the group tax free with intercompany loans.
Profits can be ringfenced in the different entities within a group structure until being moved at the appropriate time.
3. Commercial or Regulatory Necessity
It may be necessary to set up a subsidiary in a different jurisdiction to win work in that jurisdiction. For example, to win a public sector project in Ghana it may be necessary to set up a company in Ghana. It may be a requirement within the tender documents themselves or it may be the most efficient way to deal with the hiring of local staff and suppliers and the payment of local taxes.
It may be necessary to establish a local entity to obtain regulatory licences.
4. Most efficient way to work with another business
Setting up a subsidiary which is partly owned by another business that you want to work with may be the best way to structure the relationship. For example it may be a better way for intellectual property which is created by the two businesses to be held (in one entity) rather than provide for joint ownership of IP through contractual rights which must set out, for example, how management and exploitation of the IP assets would be undertaken.
Setting up a UK subsidiary
A non-UK company that intends to trade in the UK could set up a UK tax resident subsidiary. The subsidiary would be subject to UK corporation tax on its worldwide profits and gains (both income and capital), subject to the foreign permanent establishment exemption to the extent that the UK tax resident subsidiary itself has any non-UK operations.
The foreign parent should consider carefully the inter-company arrangements between that subsidiary and the parent entity to ensure that the subsidiary does not itself create a permanent establishment of the parent company in the UK. This could be the case, for example, if the subsidiary acts as a dependent agent of the parent.
Setting up the company is relatively straightforward. You can use a formations agent to set up the subsidiary within 48 hours at little expense. The company must be registered with the Registrar of Companies at Companies House.
All UK limited companies must prepare and file annual accounts. If the company is over a certain size – if its turnover exceeds £10.2 million or its balance sheet exceeds £5.1m or it has more than 50 employees on average – it must have an annual independent audit.
Directors are personally responsible for submitting yearly accounts and the company’s annual return to the Registrar of Companies. Penalties are payable in the event of non-compliance.
Upon registration of a new company, Companies House will pass on the details to the UK’s tax authority – HM Revenue & Customs (HMRC). The company will also need to contact its local HMRC office within three months of formation. The company will need to register online for corporation tax.
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