You may be familiar with the term ‘holding company UK’ but what does it refer to? How does such a company differ from a standard company, what is its purpose and what are the advantages? We’ll take an in-depth look at how this type of business operates.
How may a holding company be defined?
Unlike a standard business or enterprise which makes a profit from the provision of goods and services, a holding company owns sufficient shares in other companies to control their operations and management.
The main reason for forming a holding company is to own the group’s assets and investments such as intellectual property (patents and trademarks), shares and real estate. In the UK, holding companies that own 50% or more of the companies’ shares are known as ‘parent’ companies and the companies within the group as ‘subsidiaries’.
Grouping companies together under the umbrella of a holding company gives them benefits they would not have as separate companies.
The tax advantages of a holding company
A major advantage is the potential for tax savings because the majority of share disposals and dividend payments are exempt from tax. Companies with a turnover of less than £10 million do not pay tax on dividends, so they can take the profits of a subsidiary as dividends tax-free.
Subject to certain conditions, the holding company can dispose of shares in the subsidiaries without incurring any liability for corporation tax, by virtue of the substantial shareholding exemption (SSE). That is provided that the holding company and its subsidiaries are active businesses for 12 months before and after the disposal.
The holding company could also be exempt from value added tax (VAT) unless its annual income exceeds £85,000, in which case compulsory registration will apply. Or the holding company supplies services such as management or accountancy which would attract VAT.
Losses incurred by a subsidiary can be offset against the profits of the other subsidiaries if the holding company files a consolidated tax return, which would result in a lower tax bill for all the subsidiaries.
Another way to limit tax liability would be to locate parts of the business in countries with low tax rates.
Limitation of Risk
One important benefit for the holding company is limitation of risk – ring-fencing valuable assets – to protect them against claim if the trading company is subject to litigation. If a subsidiary becomes bankrupt, the holding company will suffer a capital loss and a decrease in its net worth, but it cannot be pursued for remuneration by the failed company’s creditors. In this way, both holding company and all subsidiaries benefit from limited financial and legal liability.
The subsidiaries are protected from events that occur in the sister companies. A judgment against one subsidiary cannot be extended to the rest of the group. In addition, the holding company would not be liable if it had not guaranteed the subsidiary’s debts.
An adverse event such as bankruptcy on the part of a subsidiary will not affect the holding company which will be entitled to sell the company’s shares.
An individual’s personal assets can be protected too. If the assets are owned by the holding company rather than the individual, it is the company that will be liable for any debts.
The combined strength of the group
The holding company may possess specialist skills and knowledge that could be made available to the subsidiaries to increase their value, or it could seek out particular competences such as superior marketing and sales practice in one subsidiary that could be applied to the rest of the group.
It is possible that more favourable terms for borrowing could be obtained through the combined financial strength of the group than separately by the subsidiaries. By the same token, subsidiaries in the same industry could join forces to gain better prices and credit terms from vendors.
The holding company would be enabled to take on larger-scale projects by means of pooling its own financial resources together with those of the subsidiaries.
Achieving more control with less capital
A holding company would allow a business to control more subsidiaries using less capital. The takeover of a company could be achieved by the acquisition of 51% of its stock. Where ownership is diverse, i.e. where there are many small shareholders, control could even be achieved by the purchase of only 25% of the stock, making the holding company the largest shareholder.
The opportunity to purchase less than 100% of a company enables a small business owner to control more companies with a smaller outlay and to diversify his business without taking needless risks. Using the resources of a holding company and its subsidiaries creates a sum total greater than its parts in terms of purchasing power, borrowing costs and the ability to invest in larger-scale projects.
In the case of a business owner contemplating selling up, having a holding company would mean he would not have to sell the entire business or could add value by selling parts of it strategically and at different times.
However, although the formation of a holding company can be highly beneficial, there may be some disadvantages for both holding company and subsidiaries.
As a holding company has a controlling interest in its subsidiaries, it could face problems in a turbulent market in maintaining profitability and solvency or converting its assets quickly enough to avoid losses, whether the investments held are mainly in one line of business or diversified across many sectors.
Lack of expertise
The management of the holding company may lack knowledge of the subsidiary, its modus operandi and investment rationale, resulting in poor decision-making. They may also, through inexperience, be reluctant to challenge the status quo giving rise to an inadequate response to competition and market conditions.
Conflict of interest
The management of the subsidiary will have to become accustomed to a new regime, reporting to a new board of directors and a larger body of shareholders, while continuing to focus on the needs of their own shareholders. The requirement to satisfy two, sometimes conflicting, sets of aims and objectives could result in discord and weak decision-making.
If you are considering forming a holding company UK, it would make sense to consult a tax specialist to ensure you do not pay more tax than you owe.