Subsidiary company or when an octopus called holding is created

What is a subsidiary?

If you think of an octopus, a subsidiary is one of the tentacles that are an integral part of the body – the parent company. The latter is the one who controls the subsidiary. This control may consist, for example, in owning a majority of the share capital. But the parent company can also have a decisive influence on the management and operation of the subsidiary. This relationship has, of course, economic as well as legal implications.

A grouping of these companies is then called a holding company. The holding company has as its main objective to own and manage shares in other companies – including those of the subsidiary. Holding companies are usually formed to enable companies to optimise taxes, manage risks or manage their assets more efficiently.

A subsidiary is subordinate to its sister company. Sister companies have the same parent company but are not directly subordinate to each other. Whereas a subsidiary is subordinate to its parent.

How are subsidiaries regulated by law in the Czech Republic?

The legal regulation of subsidiaries in the Czech Republic is based on the Commercial Corporations Act. It replaces the former Commercial Code. The Commercial Corporations Act defines both the forms of commercial companies and the rules for relations between parent and subsidiary companies.

The parent company’s imaginary scepter is the controlling contract. This gives it the right to give instructions to the subsidiary. The control agreement must be entered in the commercial register. However, a controlling agreement is not a necessary condition for the parent-subsidiary relationship. The parent company can exercise decisive influence without a formal control agreement, for example by owning a majority share or by other control mechanisms.

The parent company then has a duty to protect not only its own interests but also those of the subsidiary and its creditors. This means that the subsidiary cannot be used to transfer assets or engage in other practices that could jeopardise the solvency of the subsidiary.

How to set up a subsidiary

The process of setting up a subsidiary is basically the same as setting up any other company. There are a few simple steps to follow.

1. Choosing the legal form: The most common choice for a subsidiary that companies resort to is a limited liability company (LLC) or a joint stock company (JSC). Each of these forms has its own specifics, such as different requirements for share capital and internal structure. We have dealt with these in separate articles.
2. Share capital: the parent company usually finances the formation of the subsidiary, either by investing in it or by transferring assets to it. The law makes the establishment of an LLC conditional on a share capital of CZK 1, which allows companies great flexibility.
3. Certificate of incorporation: in the certificate of incorporation it is necessary to state the name, registered office, object of business and share capital. In the case of a subsidiary, the deed must also contain information about the ownership structure and the relationship to the parent company.
4. Commercial register: in order to complete the entire incorporation process, the company must apply for registration of the subsidiary in the commercial register. For this, the articles of incorporation, consent to the location of the registered office and other mandatory documents must be submitted.
5. Taxes and accounting: as the subsidiary is a separate tax entity, it must keep its own accounts. However, it is often the case that tax optimisation is carried out at the level of the entire holding company.

Why is it advantageous to be part of a holding structure?

One of the most important advantages is tax optimization. The holding company can efficiently shift profits between subsidiaries to achieve minimum taxation. Thanks to international tax planning, the entire holding company based in a tax-friendly country can pay less.

Asset protection is also worth mentioning. Because each subsidiary operates as a separate legal entity, the assets of one company are not automatically at risk from the liabilities of another company within the holding company. It is the same with the separation of business activities, where a company can operate different types of business and create separate subsidiaries for them to reduce the risk of problems in one part negatively affecting the whole business.

Efficient intra-group transfers, whether of assets, employees or technology, can also take place within the holding company.

What about the disadvantages of a subsidiary?

The disadvantages certainly include the increased administrative burden. Each subsidiary has to keep separate accounts, file tax returns and comply with local legislation. Due to the complexity of holding structures, legal and tax specialist fees can also increase.

The subsidiary also has to deal with potential liability to the parent company. While we have said that the parent company is not liable for the liabilities of subsidiaries, there may still be exceptions:

• In some countries, a holding company may also be liable for the debts of its subsidiary if it can be shown that it effectively controls it.
• There is also reputational risk, as problems in a subsidiary can damage the reputation of the group as a whole.
• And if the parent company guarantees or directly finances the subsidiary, it will also be liable for its liabilities.

How to set up internal processes?

When managing a subsidiary, you need to set clear responsibilities, accountabilities, control mechanisms and strategic decision-making processes.

Statutory bodies

Who runs the subsidiary is usually in the hands of the parent company thanks to its decision-making power. It usually designates the statutory bodies that must carry out the day-to-day management of the company. Thus, the parent company appoints the members of the board of directors or the managing directors, and in some cases the management may be held by managers and representatives of the parent company. These bodies must comply with legal regulations, manage the company in accordance with the holding company’s business strategy, fulfil their obligations to the parent company, ensure transparent accounting and report regularly.

Control mechanisms

Effective management of a subsidiary is not without regular supervision and control. The subsidiary must therefore report regularly on its financial performance. At the same time, it often has limited decision-making powers– for example, major investments or changes in strategy must be approved by the parent company. The latter also has oversight of the budget, setting financial limits. External audits often take place at subsidiary level.

Strategic decision-making

The parent company decides how funds are allocated between subsidiaries. The subsidiary may raise funds from equity, intercompany loans or consumer loans.

If a subsidiary plans to expand, develop a new product or enter a new market, it cannot do so until the parent company approves it. The latter can also order it to restructure, merge or even liquidate.

Successful holding companies

In the Czech Republic, PPF Group and Agrofert are among the biggest players in the field of holding companies. Both groups benefit from a diversified portfolio and efficient management of their subsidiaries. By successfully setting up all internal processes, both groups have minimised business risks and maximised their profits.

PPF Group operates globally in financial services, telecommunications, real estate and biotechnology investments. Agrofert specialises in agriculture, chemicals and media. Thanks to its efficient holding structure, it can manage dozens of subsidiaries.

Where does it stink?

One common problem is when the parent company promotes its interests at the expense of the subsidiary. This then leads to extensive litigation and disruption of business relationships. We see that conflicts between parent and subsidiary arise mainly on issues of profit transfers, management practices or the interpretation of control agreements. Based on our experience, we therefore recommend leaving the preparation of all documentation to lawyers who will ensure that there are no loopholes in contracts and deeds and no room for ambiguous interpretation.

Summary

Subsidiaries are an integral part of holding structures and are subject to specific legal and economic rules. The parent company usually determines their statutory bodies, sets control mechanisms and influences strategic decisions, for example in the area of financing or expansion. Effective governance includes regular audits, transparent accounting and reporting by the parent company. Subsidiaries can benefit from the advantages of a holding structure, such as tax optimisation or asset protection, but also face administrative burdens and potential conflicts with the parent company. Carefully set up internal processes and properly formulated contracts are key to their successful operation.