Subsidiary: How Does It Work and Who Controls It?

Quick Overview

• A subsidiary is an independent business entity over which another business entity exercises controlling influence.
• The parent company acts as the controlling entity, while the subsidiary is the controlled entity.
• Control may result from a majority of voting rights, the ability to appoint members to the subsidiary’s governing bodies, or other means of exercising decisive influence.
• A subsidiary is liablefor its debts with its own assets. The parent company is not automatically liable for these debts, but under certain conditions, it may be liable for any resulting damages.
• The establishment of a subsidiary follows the rules for the chosen legal form, such as a limited liability company (s. r. o.) or a joint-stock company (a. s.).

Are you establishing a subsidiary, or do you need to legally structure the relationships between companies within a holding group? Our attorneys will assist you in preparing the founding documents and establishing the rules between the parent and subsidiary companies to ensure compliance with the law and protect your business.

What is a subsidiary?

If you imagine an octopus, a subsidiary is one of its tentacles, which are an integral part of the body—the parent company. The parent company is the entity that controls the subsidiary. This control may consist, for example, of owning a majority stake in the share capital. However, the parent company may also have a decisive influence on the management and operations of the subsidiary. This relationship naturally has both economic and legal implications.

We refer to a group of these companies as a holding company. The primary objective of a holding company is to own and manage stakes in other companies—including its subsidiaries. Holding companies are usually established so that firms can optimize their taxes, manage risks, or administer their assets more efficiently.

Unlike a sister company, a subsidiary is subordinate. Sister companies share the same parent company but are not directly subordinate to one another. A subsidiary, on the other hand, is subordinate to its parent company.

Controlling and Controlled Entities—What Is the Difference Between Them?

The Business Corporations Act distinguishes between two basic concepts: a controlling entity and a controlled entity. A controlling entity is one that can exercise decisive influence, directly or indirectly, over a business corporation. A controlled entity is a business corporation subject to such influence.

If the controlling entity is a business corporation, the law refers to it as a parent business corporation. Conversely, the controlled business corporation is a subsidiary.

Decisive influence may arise, for example, from voting rights or the ability to secure the appointment of a majority of the members of the company’s governing bodies. Therefore, mere ownership of a certain shareholding does not always accurately indicate who actually controls the company.

Example: Alfa s. r. o. owns a 100% stake in Beta s. r. o. and exercises all the voting rights of its sole shareholder. In this case, Alfa is the parent and controlling company, while Beta is the subsidiary and controlled company. Nevertheless, they are two separate legal entities.

It is also important to distinguish between ordinary control and a corporate group. Not every parent and subsidiary company automatically forms a corporate group within the meaning of the law. A corporate group is characterized by unified management, in which a controlling entity coordinates the significant activities of other companies over the long term in the interest of the entire group.

How does the law in the Czech Republic regulate subsidiaries?

The legal framework governing subsidiaries in the Czech Republic is based on the Business Corporations Act. This Act replaces the former Commercial Code. The Business Corporations Act defines both the forms of business entities and the rules governing the relationships between parent and subsidiary companies.

No special control agreement is required to establish a relationship between a parent and a subsidiary. What matters is the actual ability to exercise direct or indirect controlling influence, for example, through voting rights.

If companies form a corporate group, the Business Corporations Act allows the controlling entity, under certain conditions, to issue instructions to the governing bodies of the controlled company regarding business management, provided such instructions are in the interest of the corporate group. Even in such a case, however, the members of the subsidiary’s governing bodies remain responsible for the proper performance of their duties.

The parent company is then obligated to protect not only its own interests but also those of the subsidiary and its creditors. This means that it may not misuse the subsidiary to transfer assets or engage in other practices that could jeopardize the subsidiary’s solvency.

How to Establish a Subsidiary

The process of establishing a subsidiary is essentially the same as establishing any other business entity. There are a few simple steps to follow.

1. Choosing a Legal Structure: The most common legal structures companies choose for a subsidiary are a limited liability company (s. r. o.) or a joint-stock company (a. s.). Each of these forms has its own specific characteristics, such as different requirements for registered capital and internal structure. We’ve covered these in separate articles.
2. Share Capital: The establishment of a subsidiary is usually financed by the parent company, either through an investment or by transferring assets to the subsidiary. The law requires a minimum share capital of 1 Kč to establish an s. r. o., which allows companies a great deal of flexibility.
3. Articles of Incorporation: The articles of incorporation must specify the name, registered office, scope of business, and registered capital. For a subsidiary, the articles must also include information on the ownership structure and the relationship to the parent company.
4. Commercial Register: To complete the entire incorporation process, the company must file an application to register the subsidiary in the Commercial Register. To do so, it must submit the articles of incorporation, approval of the registered office location, and other required documents.
5. Taxes and Accounting: Since a subsidiary is a separate tax entity, it must maintain its own accounting records. However, tax optimization often takes place at the level of the entire holding company.

Why Is It Advantageous to Be Part of a Holding Structure?

One of the most significant advantages is tax optimization. A holding company can effectively shift profits among its subsidiaries to minimize its tax liability. Through international tax planning, the entire holding company—based in a country with favorable tax rates—can pay less in taxes.

Asset protection is certainly worth mentioning as well. Each subsidiary operates as a separate legal entity, so the assets of one company are not automatically at risk due to the liabilities of another company within the holding company. The same applies to the separation of business activities, where a company can operate different types of businesses and create separate subsidiaries for them to reduce the risk that problems in one division will negatively impact the entire enterprise.

Within a holding company, efficient intra-group transfers can also take place, whether of assets, employees, or technology.

Do you want to establish a subsidiary but aren’t sure how to properly structure its relationship with the parent company? We’ll prepare the necessary incorporation documents for you, help you set up ownership structures, and highlight the legal obligations that come with a holding company structure.

What about the disadvantages of a subsidiary?

One of the disadvantages is certainly the increased administrative burden. Each subsidiary must maintain separate accounting records, file tax returns, and comply with local laws and regulations. Given the complexity of holding company structures, fees for legal and tax professionals may also increase.

At the same time, a subsidiary must contend with potential liability toward the parent company. Although we’ve said that the parent company is not liable for the obligations of its subsidiaries, there may still be exceptions:

• In some countries, a holding company may be liable for its subsidiary’s debts if it can be proven that it effectively controls the subsidiary.
• Furthermore, there is reputational risk, as problems at a subsidiary can damage the reputation of the entire group.
• And if the parent company provides guarantees to the subsidiary or directly finances it, it will also be liable for the subsidiary’s obligations.

How should internal processes be set up?

When managing a subsidiary, it is necessary to establish clear authorities, responsibilities, control mechanisms, and strategic decision-making processes.

Governing Bodies

The parent company usually has the final say in who will lead the subsidiary, thanks to its decision-making authority. It typically appoints the statutory bodies responsible for the day-to-day management of the company. The parent company thus appoints members of the board of directors or executive officers; in some cases, managers and representatives of the parent company may serve in leadership roles. These bodies must comply with legal regulations, manage the company in accordance with the holding company’s business strategy, fulfill their obligations to the parent company, ensure transparent accounting, and submit regular reports.

Control Mechanisms

Effective management of a subsidiary requires regular oversight and control. The subsidiary must therefore submit regular reports on its financial results. At the same time, it often has limited decision-making authority—for example, major investments or changes in strategy must be approved by the parent company. The parent company also oversees the budget by setting financial limits. External audits are frequently conducted at the subsidiary level.

Strategic Decision-Making

The parent company decides how funds will be allocated among the individual subsidiaries. A subsidiary can obtain financing through equity, intra-group loans, or consumer loans.

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

Successful Holding Companies

In the Czech Republic, PPF Group and Agrofert are among the largest players in the holding company sector. Both groups benefit from a diversified portfolio and effective management of their subsidiaries. Thanks to the successful implementation of all internal processes, both groups have minimized business risks and maximized their profits.

PPF Group operates globally in the areas of financial services, telecommunications, real estate, and biotechnology. Agrofert, on the other hand, specializes in agriculture, the chemical industry, and media. Thanks to its efficient holding structure, it is able to manage dozens of subsidiaries.

Where Do the Problems Lie?

One common problem is when a parent company pursues its own interests at the expense of a subsidiary. This then leads to extensive legal disputes and disruptions in business relationships. We have observed that conflicts between parent and subsidiary companies arise primarily over issues such as profit transfers, management practices, or the interpretation of control agreements. Based on our experience, we therefore recommend entrusting the preparation of all documentation to attorneys, who will ensure that contracts and legal documents contain no loopholes or room for ambiguous interpretation.

Let’s imagine a holding company in which the parent company decides that its subsidiary will transfer part of its assets to another company within the same group at a price significantly lower than the market rate. This may cause harm to the subsidiary, which in turn could jeopardize its creditors. In such a situation, it is necessary to assess not only the liability of the individuals who pushed through the transfer but also whether the legal conditions for any compensation for damages within the group were met. The mere fact that both companies belong to the same holding company does not justify a problematic transfer.

Summary

A subsidiary is an independent business corporation over which another business corporation exercises decisive influence. Under the Business Corporations Act, this constitutes a relationship between a controlling entity and a controlled entity. The parent company may influence the subsidiary’s key decisions but must respect its legal autonomy and the statutory obligations of its governing bodies. Subsidiaries make it possible to segregate business risks, manage assets more effectively, and organize the group’s operations. At the same time, however, they entail administrative and legal obligations, including maintaining separate accounting records and, as a rule, preparing a report on the relationship. For them to operate safely, it is therefore important to properly establish the ownership structure, contractual relationships, and management rules.