A holding company is a business entity that owns a controlling interest in the stock or assets of other companies. Its primary purpose is to manage and control subsidiary companies, rather than producing goods or services itself.
Holding companies benefit from centralized management and can reduce risk by diversifying their investments across various industries. This structure allows for efficient capital allocation and strategic oversight, enhancing the overall financial health and growth potential of its subsidiaries.
What is a personal holding company?
A Personal Holding Company (PHC) is a corporation primarily owned by a small number of individuals, typically five or fewer, and primarily earns passive income such as dividends, interest, rents, and royalties. The IRS imposes additional taxes on PHCs to prevent individuals from using these entities to avoid higher personal income tax rates.
PHCs are subject to specific regulatory requirements and must meet certain income and ownership tests to be classified as such. The primary goal of a PHC is often to hold investments and manage income efficiently for its shareholders.
Holding company examples
- Berkshire Hathaway: Owns diverse subsidiaries, including GEICO and Dairy Queen.
- Alphabet Inc.: The parent company of Google, managing various subsidiaries in tech and research.
- Johnson & Johnson: Owns numerous healthcare and pharmaceutical companies.
- Procter & Gamble: Manages a wide range of consumer goods brands.
- Sony Corporation: Controls various entities in electronics, entertainment, and financial services.
These examples demonstrate the varied industries and operations managed under the umbrella of holding companies, showcasing their strategic importance in the business world.
Features of a holding company
- Ownership structure: Owns significant shares or full ownership of other companies (subsidiaries).
- Centralized management: Provides strategic direction and management to its subsidiaries.
- Passive income: Generates income through dividends, interest, and capital gains from its subsidiaries.
- Risk mitigation: Diversifies investments to reduce risk exposure.
- Limited liability: Limits liability to the holding company's assets, protecting individual subsidiaries.
- Capital allocation: Efficiently allocates capital and resources across subsidiaries.
- Tax benefits: May offer tax advantages through consolidated tax returns and inter-company transactions.
- Acquisitions and mergers: Facilitates easier acquisitions and mergers by leveraging existing assets.
Uses of a holding company
- Asset protection: Shields parent company’s assets from liabilities of individual subsidiaries.
- Operational efficiency: Streamlines operations by centralizing management and administrative functions.
- Tax optimization: Utilizes tax strategies to minimize overall tax burden through subsidiaries.
- Risk management: Diversifies investments to spread and manage financial risks effectively.
- Capital management: Allocates capital efficiently among subsidiaries for growth and expansion.
- Strategic acquisitions: Facilitates acquisitions and mergers by using subsidiary companies.
- Legal structure: Creates a legal structure that separates operational risks from the holding company.
- Financial synergy: Leverages financial synergies between subsidiaries to improve overall profitability.
Assets necessary for a holding company
- Intellectual property: Patents which are intellectual property rights that protect inventions and innovations. Trademarks which make up legal protection for brand names, logos, and symbols used in commerce. Copyright are rights to original works of authorship, including literary, musical, and artistic creations.
- Subsidiaries: Ownership of shares in other companies to control their operations and profits.
- Real estate: Property investments for long-term value and rental income.
- Financial investments: Stocks, bonds, limited liability companies and other securities for diversification and income.
Advantages and disadvantages of a holding company
The advantages are:
- Asset protection: Shields parent company assets from subsidiary liabilities.
- Tax benefits: Allows for tax optimization through consolidated tax filings.
- Diversification: Spreads investment risk across various industries.
- Control: Maintains control over subsidiaries while allowing operational independence.
- Capital allocation: Efficiently allocates resources among subsidiaries for growth.
- Strategic flexibility: Facilitates easier mergers and acquisitions.
- Economies of scale: Centralizes administrative functions to reduce costs.
- Legal separation: Distinguishes liabilities and risks among different entities.
The disadvantages are:
- Complexity: Managing multiple subsidiaries increases organizational complexity.
- Regulatory compliance: Requires adherence to diverse regulatory frameworks.
- Cost: Higher administrative and legal costs due to multiple entities.
- Risk of failure: Poor performance of one subsidiary can impact the entire group.
- Decision-making delays: Centralized control can slow down subsidiary decisions.
- Financial reporting: Consolidated financial reporting can be cumbersome.
- Limited direct control: May reduce direct control over subsidiary operations.
- Potential for conflicts: Conflicts of interest may arise between parents and subsidiaries.
Types of holding companies
- Pure holding company: Exists solely to own shares of other companies without direct operations.
- Mixed holding company: Owns shares of other companies and engages in its own operations.
- Immediate holding company: A company that is both a subsidiary and a parent company.
- Intermediate holding company: Sits between the ultimate holding company and its subsidiaries.
- Financial holding company: Primarily involved in financial services and investment activities.
- Operational holding company: Engages in operational activities while holding control over subsidiaries.
- Bank holding company: Controls one or more banks and complies with specific regulatory requirements.
- Multinational holding company: Manages and controls subsidiaries in multiple countries.
How Does a Holding Company Work?
A holding company works by owning and controlling shares in other companies, known as subsidiaries, instead of being directly involved in daily business activities. Here is how it works:
- Ownership and control: The holding company buys a large portion (usually 51% or more) of shares in other companies, which gives it control over these subsidiaries. By holding the majority of shares, it can influence major decisions in the subsidiaries, such as business strategies, policies, and senior management. In some cases, the holding company may own 100% of a subsidiary, giving it full control
- Independent legal entities: Both the holding company and each subsidiary are separate legal entities. This means the subsidiaries have their own liabilities and obligations, which helps protect the holding company from any legal or financial issues faced by a subsidiary. This separation also allows each subsidiary to focus on its own business while the holding company provides oversight
- Centralised management and oversight: The holding company does not manage the daily operations of its subsidiaries. Instead, it oversees strategic decisions, manages assets, and may provide services like legal, HR, or accounting support. This structure helps the holding company improve efficiency across multiple subsidiaries by sharing resources and cutting down on unnecessary functions
- Income generation: The holding company generates income in several ways, including
- Dividends from profits made by subsidiaries
- Interest on loans it gives to subsidiaries
- Royalties or licensing fees for intellectual property it owns but is used by subsidiaries
- Management fees for services it offers to subsidiaries, such as consulting, legal, or HR services
- It may also earn capital gains if it sells shares in a subsidiary for a profit
- Risk management and asset protection: By holding valuable assets like intellectual property, property, or large cash reserves, the holding company protects them from the risks faced by its subsidiaries. If one subsidiary faces financial or legal trouble, it typically will not affect the other subsidiaries or the holding company itself.
How do holding companies make money?
Holding companies generate revenue through dividends, interest, and capital gains from their subsidiaries and investments. By owning significant shares in various companies, they receive regular dividend payments. They may also earn interest from loans extended to their subsidiaries.
Additionally, holding companies benefit from capital gains when they sell their shares in these companies at a higher price than the purchase cost. Real estate holdings and intellectual property such as patents and trademarks can also provide income through royalties and lease agreements, diversifying their revenue streams.
What is the purpose of a holding company?
The primary purpose of a holding company is to own and manage a portfolio of assets and investments, including shares in other companies, real estate, and intellectual property. By doing so, it centralizes control and oversight while allowing its subsidiaries to operate independently.
This structure provides risk management, as liabilities of the subsidiaries do not typically affect the holding company. Additionally, it offers tax advantages, operational efficiency, and strategic investment opportunities, enabling the holding company to focus on maximizing returns and growth while minimizing risks associated with direct business operations.
Holding company registration process
1. Digital Signature Certificate (DSC):
Obtain a Digital Signature Certificate for the directors of the company. This is necessary for filing electronic documents with the Registrar of Companies (RoC).
2. Director Identification Number (DIN):
Apply for a Director Identification Number for the proposed directors of the company. This unique identification number is mandatory for anyone intending to be a director.
3. Name approval:
Propose a unique name for the holding company and submit it to the Ministry of Corporate Affairs (MCA) for approval. The name should not be identical or similar to existing companies.
4. Preparation of documents:
- Memorandum of Association (MoA): Draft the Memorandum of Association, which outlines the company’s objectives and scope of activities.
- Articles of association (AoA): Draft the AoA, which details the company’s internal management rules.
5. Company registration:
- Fill out the incorporation form (SPICe+ form) on the MCA portal.
- Attach the DSC, DIN, MoA, AoA, and other required documents such as proof of identity and address of directors, and registered office address proof.
- Pay the required fees and submit the application for company registration.
6. Certificate of incorporation:
- Upon verification, the RoC issues the Certificate of Incorporation, which includes the Corporate Identification Number (CIN).
- This certificate confirms that the company is legally recognized as a holding company.
7. Post-incorporation compliance:
- Apply for a Permanent Account Number (PAN) and Tax Account Number (TAN).
- Open a company bank account.
- Register for Goods and Services Tax (GST) if applicable.
These steps ensure that the holding company is registered in compliance with the legal and regulatory framework, allowing it to own and manage its subsidiaries effectively.
Does a Holding Company Pay Income Tax in India?
In India, a holding company is required to pay income tax on its earnings, just like any other company. The taxation of holding companies is governed by the Income Tax Act of 1961, and they are taxed on their global income, including dividends, interest, capital gains, and other income sources.
Corporate tax rates
- Standard rate: A domestic holding company is generally taxed at a base rate of 30% on its net income
- Reduced rate for smaller companies: Companies with an annual turnover of up to Rs. 400 crore (as per the previous year's financial statements) are taxed at 25%
- Optional tax regime: Under Section 115BAA, domestic companies can choose a reduced tax rate of 22% (effective rate around 25.17%, including surcharge and cess), provided they give up certain exemptions and deductions
Surcharge and cess
- A surcharge ranging from 7% to 12% is applied depending on taxable income
- Health and Education Cess is charged at 4% on the tax amount, including the surcharge
Dividend income
- From April 1, 2020, India removed the Dividend Distribution Tax (DDT). Dividends paid by subsidiaries are now taxable in the hands of the shareholders, including holding companies
- Dividends received from a subsidiary are included in the holding company’s taxable income and are taxed at the applicable corporate tax rate
Section 80M deduction
- To prevent double taxation of dividends within a corporate group, Section 80M allows a domestic holding company to claim a deduction for dividends received from domestic subsidiaries, provided it distributes those dividends to its own shareholders before the due date of filing the return
- Example: If a parent company receives Rs. 10 lakh as dividends from its subsidiary and redistributes Rs. 8 lakh to its shareholders, it can claim a deduction of Rs. 8 lakh under Section 80M.
Interest income and other income
- Income from interest on loans to subsidiaries, royalties, or fees for technical services is taxed at regular corporate tax rates
- This income must be reported and is subject to transfer pricing regulations if the transactions are with related parties
Capital gains
- Short-term capital gains (STCG): Assets held for less than 36 months (12 months in the case of shares) are classified as short-term. STCG is taxed at the normal corporate tax rates
- Long-term capital gains (LTCG): Assets held for over 36 months (12 months for shares) are long-term. LTCG on the sale of listed equity shares over Rs. 1 lakh is taxed at 10% without indexation benefits. LTCG on other assets is taxed at 20% with indexation benefits
Set-off and carry forward of losses
Holding companies can set off business losses and unabsorbed depreciation against future income, subject to certain conditions. Business losses can be carried forward for up to eight assessment years
Minimum alternate tax (MAT)
Companies not opting for the reduced tax rates under the new tax regime are subject to MAT under Section 115JB at 15% of book profits (plus surcharge and cess). Companies opting for the tax rates under Section 115BAA or 115BAB are exempt from MAT
Transfer pricing regulations
Transactions between the parent company and its subsidiaries, if they are related parties, must comply with transfer pricing rules to ensure the transactions are carried out at arm's length prices
Compliance requirements
- Tax audits: If the turnover exceeds the specified threshold (currently Rs. 10 crore for businesses with less than 5% cash transactions), the company must have its accounts audited under Section 44AB
- Advance tax payments: Holding companies must pay advance tax in four instalments during the financial year if their estimated tax liability exceeds Rs. 10,000
- Filing of income tax returns: The company must file its annual income tax returns by the due date (usually October 31 for companies that need an audit) to avoid penalties
How to start a holding company?
- Business idea: Define a clear business idea focused on owning and managing multiple subsidiary companies.
- Business plan: Develop a detailed business plan outlining objectives, strategies, financial projections, and management structures.
- Legal structure: Choose a suitable legal structure (e.g., LLC, corporation) and ensure it supports holding company operations.
- Registration: Register the holding company with the relevant authorities, obtaining necessary permits and licenses.
- Digital Signature Certificate (DSC): Obtain DSCs for the directors.
- Director Identification Number (DIN): Apply for DINs for all directors.
- Documentation: Prepare and file the Memorandum of Association (MoA) and Articles of Association (AoA).
- Company incorporation: Submit the incorporation application on the MCA portal and obtain the Certificate of Incorporation.
- Bank account: Open a business bank account for financial transactions.
- Funding: Secure funding through personal savings, investors, or a business loan for initial investments in subsidiaries.
Exploring Bajaj Finserv Personal Loan:
If you need funds to manage the company, business loan is a great option to consider. Here are some of the key advantages of Bajaj Finserv Business Loan:
- Rapid disbursement: Funds can be received in as little as 48 hours of approval, allowing businesses to respond promptly to opportunities and needs.
- Simplified application process: Online applications streamline the process, reducing paperwork and saving time.
- High loan amount: Businesses can borrow funds up to Rs. 80 lakh, depending on their needs and qualification.
- No collateral required: You do not have to pledge any collateral to get our business loan, which is beneficial for small businesses without substantial assets.
- Competitive interest rates: The interest rates for our business loans range from 14% to 30% per annum.
Conclusion
Starting a holding company involves a clear business idea, a robust business plan, and meticulous compliance with legal formalities. Securing a business loan can provide the necessary capital to acquire and manage subsidiary companies, facilitating growth and diversification. Proper planning and execution are key to establishing a successful holding company, ensuring long-term financial stability and strategic expansion.
