Essentially, a holding company is a business entity that owns other companies but unlike a parent company, it doesn’t manage or operate them. This is an important distinction which is often misunderstood but which makes a huge difference in how these companies are structured and function.
To help clear up this confusion and answer other common questions, this article will explain everything you need to know about holding companies including how they work, how to set one up, and the legal and tax implications you need to be aware of.
What are Holding Companies?
As its name suggests, a holding company is a company which holds (owns) other subsidiary companies. The holding company may be a parent company or it may be completely unrelated to the subsidiary companies.
This type of company structure is fairly common and there are many examples of large, well-known holding companies. Some of the most notable include Berkshire Hathaway, which owns more than 60 subsidiary companies including GEICO, BNSF Railway and Dairy Queen; Alphabet Inc., which owns Google, YouTube and Nest; and News Corporation, which owns Fox News, The Wall Street Journal and HarperCollins.
What are the Different Types of Holding Companies?
There are two main types of holding companies: private and public. A private holding company is not traded on a stock exchange whereas a public holding company is. There are several advantages and disadvantages of both, including:
Advantages of a Private Holding Company:
There is less paperwork and fewer regulatory requirements.
They are easier and cheaper to set up.
The owners have more control over the company.
They are not subject to stock market fluctuations.
Disadvantages of a Private Holding Company:
They can be difficult to sell.
There may be restrictions on how the company can raise capital.
The owners may have difficulty accessing capital markets.
Advantages of a Public Holding Company:
They have more credibility with investors.
They can raise capital more easily.
They are easier to sell.
The shares are more liquid.
Disadvantages of a Public Holding Company:
There is more paperwork and regulatory requirements.
They are subject to stock market fluctuations.
The shareholders have less control over the company.
How do Holding Companies Work?
The way a holding company works is fairly simple. The holding company will set up a subsidiary company and then invest money into that subsidiary. The investment can be in the form of cash, assets or shares. Once the investment has been made, the holding company will own a percentage of the subsidiary.
The holding company will then have control over the subsidiary. This means that the holding company can make decisions about the direction of the subsidiary, how it is run and what happens to it. However, the holding company does not actually operate the subsidiary. That is left to the management of the subsidiary.
It is important to note that the holding company does not need to own all of the shares in the subsidiary. It can own just a minority shareholding. This is known as a non-controlling interest.
What is the Difference Between a Holding Company and a Parent Company?
A lot of people confuse holding companies with parent companies. While they are similar, there are some important differences between the two.
The main difference is that a parent company is directly involved in the management and operation of its subsidiary companies. A holding company, on the other hand, does not manage or operate its subsidiary companies. It simply holds a controlling interest in them.
Another difference is that a parent company will usually only have subsidiaries which are related to its core business. A holding company, on the other hand, can have any type of subsidiary company.
Finally, a parent company is usually much larger than a holding company. This is because a parent company will have many more subsidiaries than a holding company.
What are Holding Companies Used For?
Holding companies are used for a number of different purposes, but the most common is to protect assets. By holding assets in a separate company, they are protected from the liabilities of the other companies in the group. This is because holding companies are treated as separate legal entities from their subsidiaries.
Another common use for holding companies is to save on taxes because holding companies can take advantage of tax laws in different countries. For example, a holding company based in the Netherlands can take advantage of the country’s generous tax laws to reduce its overall tax bill. It doesn’t matter where the subsidiaries are located, the holding company will still benefit from the Dutch tax laws.
Holding companies can also be used to control a group of companies. This is because the holding company will own a controlling interest in all of the subsidiaries so it can make decisions about how the group of companies is run.
Finally, holding companies can be used to manage risk. By spreading assets across different companies, the risk is reduced. For example, if one company fails, the other companies in the group will still be able to continue operating.
How to Set Up a Holding Company
If you’re interested in setting up a holding company, there are a few things you need to do.
First, you need to choose the country where you want to base your holding company. This is because each country has different laws and regulations about how holding companies can operate. You’ll also need to set up a bank account in the country where you’re based. Some popular countries to consider include the Netherlands, Luxembourg and Switzerland.
Once you’ve chosen a country, you need to set up a legal entity for your holding company. This is usually done by setting up a limited liability company (LLC) or a corporation. You’ll also need to choose a name for your holding company and register it with the relevant authorities.
After your holding company is registered, you’ll need to open a bank account. This is so you can start transferring assets into the company. Once the assets are in the company, they’ll be protected from the liabilities of your other businesses.
You’ll also need to appoint a board of directors for your holding company. The board of directors will be responsible for making decisions about how the company is run.
Finally, you’ll need to get insurance for your holding company. This is so you’re protected from any lawsuits that might be brought against the company.
The process of setting up a holding company can vary depending on the country you’re based in, so it’s important to do your research and seek professional advice before you get started.
What Are the Tax Implications of Holding Companies?
The tax implications of holding companies can vary depending on the country you’re based in. However, there are some general principles that apply.
First, holding companies are usually taxed on their income. This is because they’re seen as separate legal entities from the businesses they own.
However, there are some cases where holding companies can be partially or wholly exempt from income tax. This usually happens when the holding company is based in a country with a low tax rate and the businesses it owns are based in countries with high tax rates. In this case, the holding company can take advantage of the tax laws in different countries to reduce its overall tax bill.
Another thing to keep in mind is that holding companies often have to pay taxes on their profits when they’re distributed to shareholders. This is because dividends are usually seen as income and are subject to income tax. Dividends are paid out of the company’s profits, so they’re usually taxed at the same rate as the company’s income.
However, there are some countries where dividends are exempt from income tax. This usually happens when the holding company is based in a country with a low tax rate and the shareholders are based in countries with high tax rates. In this case, the shareholders can take advantage of the tax laws in different countries to reduce their overall tax bills.
It’s worth noting that holding companies can often be subject to double taxation. This happens when the company is taxed on its profits and then the shareholders are taxed on their dividends. Double taxation can be avoided by using a holding company structure, but it’s important to seek professional advice before you get started.
Finally, it’s important to remember that holding companies are subject to capital gains tax. This is a tax on the profits that are made when assets are sold. Capital gains tax is usually payable when shares in the company are sold or when the company is sold itself.
The rate of capital gains tax can vary depending on the country you’re based in, but it’s usually lower than the rate of income tax. This is because holding companies are seen as long-term investments so the government wants to encourage people to invest in them.
What are the Downsides of Holding Companies?
While there are a number of advantages to using a holding company, there are also some disadvantages.
The main disadvantage is that holding companies can be complex and expensive to set up and run. This is because they need to comply with laws in different countries and file paperwork with various authorities.
Another downside is that holding companies can be difficult to understand. This is because they often have a complicated structure with different companies located in different countries. For example, a holding company based in the Netherlands might have subsidiaries in the United States, Germany and Japan where each company is subject to different business regulations and cultures.
Holding companies can also be seen as a way of avoiding taxes because they can take advantage of tax laws in different countries to reduce their overall tax bill. While this is perfectly legal, it can often result in the holding company paying less tax than it should which can cause reputational damage.
Finally, holding companies can be risky because all of the assets are held in one place. This means that if something goes wrong with the holding company, all of the assets could be lost.
The Differences Between Holding Companies and Shell Companies
Shell companies are often confused with holding companies. However, there are some key differences between the two.
First, shell companies are usually created for the purpose of tax avoidance. This means that they’re used to reduce the amount of tax that’s payable on profits. Holding companies, on the other hand, can be used for a variety of purposes and aren’t just used to avoid tax.
Second, shell companies often don’t have any real business activity. This means that they don’t decide how their assets are used or what their businesses do. Holding companies are involved in all aspects of their businesses and make the decisions about how they’re run.
Third, shell companies are often used to hide the identity of the people who own them because they’re not required to disclose their shareholders or directors. This often allows people to avoid paying taxes or hiding their assets from creditors. Holding companies are required to disclose their shareholders and directors, so they can’t be used for these purposes.
Fourth, shell companies often don’t have any employees because they don’t carry out any real business activity. Holding companies usually have employees because they’re involved in all aspects of their businesses.
Finally, shell companies are sometimes used for illegal purposes such as money laundering or funding terrorist activities. Holding companies can’t be used for these purposes because they’re required to disclose their shareholders and directors.
As you can see, the question as to what a holding company is can be a bit more complicated than it might first appear. Holding companies can be used for a variety of purposes and come with several benefits and drawbacks so if you’re thinking about setting one up, it’s important to seek professional advice to make sure that it’s the right decision for you.