In this blog post, Pritishree Dash, a student, pursuing her fourth year LLB at National University of Advanced Legal Studies, Kochi and a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses holding companies and the investments made through holding companies.
Section 2(46) of the Companies Act, 2013 defines “holding company” in relation to one or more other companies, as a company of which such companies are subsidiary companies. Simply put, a company controlled by another company is called the subsidiary company and the company exercising control are known as the holding company. The control can be exercised through control of management or ownership of shares. To understand the concept of holding company, one needs to understand what a subsidiary company as well. A subsidiary company is a company in which the holding company by its virtue of control, controls the management aspect i.e. composition of Board of Directors, management rights, voting rights, etc. The holding company by virtue of shareholding also controls more than one-half of the total share capital either wholly on its own or together with one or more of its subsidiary companies. The composition of a company’s Board of Directors is deemed to be controlled by another company (the holding company) if that other company by the exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors. A holding company holds majority-voting capital in another company.
Advantages Of Structuring Companies Into A Holding And A Subsidiary Company
- Large capital: The financial resources of the holding and subsidiary companies can be merged and hence, the company can undertake large-scale projects to increase its profit.
- Avoidance of competition: When both the holding and subsidiary company are in the same line of business, competition between holding and subsidiary companies can be avoided.
- Secrecy: Secrecy can be maintained as the authority and decision-making are centralised which prevents adverse publicity as well.
- Risks avoided: The loss on the part of the subsidiary company won’t affect the holding company badly. The holding company can sell the stakes, and the holding company can stabilise the business.
- Effective decision-making: Since the subsidiary company is maintained as a separate entity, the holding company can take decision freely regarding any business activities.
Despite having many advantages, the disadvantages are also numerous. The minority shareholders do not have a say because the holding company has 50% shareholding and becomes a dominant shareholder. This dominant position of the holding company creates a monopoly, which can have adverse effects on customers and society. The various transactions between the holding company and subsidiary company known as inter-company transactions aren’t recorded. Because they are not shown in the consolidated balance sheet, it may be manipulated to suit the convenience of controllers and act as disadvantageously to the creditors and other members of the subsidiary company. Several accounting difficulties may arise in dealing with verification and valuation to stock and recording of the inter-company transactions because the shareholders in the holding company might be unaware of the real value of their holding in the subsidiary company.
How Is Investment Through A Holding Company Made?
A holding company is a company that doesn’t have any operations, activities, or other active business itself but one which holds assets in its subsidiary companies. “These assets can be shares of stock in other corporations, limited liability companies, limited partnerships, private equity funds, hedge funds, publicly traded stocks, bonds, real estate, song rights, brand names, patents, trademarks, copyrights, or virtually anything else that has value.” Holding companies are often created by majority shareholders who have a long-term commitment to the business to manage their shareholding in group companies. Funding of a new company or a company going through a restructuring process may be difficult which can be ameliorated by setting up a holding company that seeks a credit from all sources and allowing it to finance, according to the needs of its needy subsidiaries which wouldn’t otherwise easily secure credit. The parent holding company supports the subsidiaries by lowering the cost of capital because of its power. It has the capability of issuing bonds at rock-bottom rates and lend money to its own subsidiaries at rates the subsidiaries couldn’t get had they been stand-alone enterprises. This not only increases both returns on equity but also ensures a return on assets.
A holding company has no day-to-day role in any of the investments. While each of the subsidiaries has its own management team, the holding company provides supervision and oversight. A holding company’s work is the executive oversight, support, setting risk management parameters, and putting the right people in the right places to align with corporate strategies by hiring and firing at its will in a way which is most suitable for the best returns. When subsidiaries pay out dividends to the holding company, it then invests that money by putting it to in apt areas of growing opportunities. This means the holding company can take money from one slow-growing operation and plough it into expansion for a more promising subsidiary.
If the subsidiary runs into a loss, the holding company will be stable, and the only loss that will be incurred is the investment made in the subsidiary company. Investment holding companies, which generate cash through dividends and capital gains, have to pay dividend distribution tax. “If a holding company gets a dividend from a subsidiary in which it owns over 51%, the holding company can claim credit for the tax paid to the extent of DDT paid by the subsidiary company.” “The dividend should be received from the subsidiary company; the subsidiary should have paid DDT on such dividend, and the recipient company should not be a subsidiary of any other company.”