Wholly owned subsidiaries provide tax benefits to parent company

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By: Phil Bradford
on 28th May,2015

A lot of tax benefits could be enjoyed when a company buys or creates another company as a wholly owned subsidiary.
Wholly owned subsidiaries provide tax benefits to parent company

Any wholly owned subsidiary is a standalone company floated by a parent company, but it is the parent company that will be regarded as the 100 percent owner of the stock of its subsidiary. A lot of tax benefits could be enjoyed when a company buys or creates another company as a wholly owned subsidiary. The parent company can significantly shed its tax liability and reap benefits of deductions that would have been otherwise inaccessible without the formation of the subsidiary.

Stock Purchase

As soon as a corporation buys the stock of another corporation, the controlling corporation may conduct an election to treat the buy-out as an asset acquisition in accordance to Section 338 of the Internal Revenue Code (IRC), as overseen by the Internal Revenue Service or IRS. It is a must for the controlling corporation to buy at least 80 percent of the stock of the target corporation that commands 80 percent of voting power in order to claim the buy-out as an asset purchase at the time of filing their annual tax returns. If a parent corporation overtakes a wholly owned subsidiary by buying all of the stock of another company, the purchase is regarded as a qualified stock purchase. This provision is mainly provided for tax purposes. The controlling corporation can increase their tax basis of the purchase to make that equal to the fair market value of their assets, by having their purchase considered as an asset acquisition instead of a qualified stock purchase. In case of asset purchase, a higher tax basis would result in higher amounts of depreciation deductions.

Tax-Exempt Organizations

To defend its status as a tax-exempt organization, a non-profit organization can float a for-profit wholly owned subsidiary. Tax-exempt organizations enjoy protection from paying federal taxes on their net income. However, they'll continue to enjoy such tax benefits as long as their activities are for charitable purposes. In this case, the law provides them the authority to operate their wholly owned subsidiary. This is because the subsidiary will be under the indirect control of the tax-exempt company. But it must keep performing activities that do not coincide with the mission of it tax-exempt organization. As per the IRC, the subsidiary will be subjected to federal income taxes, whereas the parent organization continues to enjoy its tax-exempt status.

Consolidated Filings

A wholly owned subsidiary can be included in a consolidated tax return along with its other affiliated group of corporations and, thus be filed by the parent company. However, the laws require the parent company to have a controlling stake over the subsidiary. For this, the parent company has to own at least 80 percent shares of stock of the subsidiary and must have the power in the same. As a result of having a controlling stake in the subsidiary, the parent company is permitted to file a consolidated tax return, reporting both income and losses incurred in a given financial year. At the time of filing consolidated tax return, both the parent company and its subsidiary is considered as one entity. Therefore, in case of any losses made by the subsidiary, the parent company can cover that up through its profits and lower tax liability.

Multiple Subsidiaries

Any company is allowed to float different wholly owned subsidiaries as separate entities. These subsidiaries can be used to drive operations for different range of products or other kinds of businesses in various industries. By filing a consolidated tax return with various subsidiaries, the profits incurred by one subsidiary can offset the losses of other subsidiaries of the same parent company or controlling organization.

The bond between a Parent Company & Its Subsidiary

To define the relationship shared by a parent organization and its subsidiary, it could well be said that a subsidiary is a wholly owned or majorly controlled organization held under the authority of a “parent company”. Companies form or buy subsidiaries on various grounds like expanding their business operations and rebalancing the risk of liability by engaging in new lines of business.

Separate Entities

Both the parent company and its wholly owned subsidiary could function as separate entities, independent of one another. In certain cases, the parent company might be the only shareholder of the subsidiary. On the other hand, in various other subsidiaries, it is their parent who owns more than 50 percent of the controlling stock. In any case, the parent company, like a typical shareholder, has the power to elect its own board of directors, which again, has the authority to select the subsidiary's management team.

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