Corporate actions create more entities and also dissolves a few. These actions are taken for the sole reason; the organization must survive.
In this business world, setting up a business and operating it effectively requires a lot of effort. With the everchanging market, new thoughts and creations must keep happening. The pace of the business must be a high-performance race car. This requires a few restructurings of the organizations too.
The restructuring may also lead to many small business enterprises dissolve and new ones sprout. The formation of new companies under the same management portfolio has many financial reasons connected to it.
A company is dissolved and can file bankruptcy. At the same time, a company can be formed and the shares can be shared between the parent company and the new entity, this helps avoid taxation for the parent company.
Further, the expense of setting up a new business is a completely tax-free affair. In the context of corporate action, two important terms emerge; Spin-off and Subsidiary.
Both these terms are interconnected to one another. The subsidiary is formed due to spin-off. However, there are differences between the two.
Spin-off vs Subsidiary
The main difference between Spin-off and Subsidiary is that Spin-of is a corporate action that forms new entities that function independently of the parent company while the new shares are offered to the existing shareholders of the old company. The subsidiary is a new legal entity that is formed by the parent company to focus on key areas of operations that the parent company requires.
Comparison Table Between Spin-off and Subsidiary (in Tabular Form)
| Parameter of Comparison | Spin-off | Subsidiary |
|---|---|---|
| Meaning/Definition | It is a corporate action that creates one or more entities that function independently of the parent company. | The subsidiary is a legally distinct new entity formed under the parent company. |
| Benefits | The spin-off is carried out for 1. Addressing financial and liability issues 2. Taxation issues | 1. The subsidiary has its own identity and 2. Functions independently. |
| Profit/Loss | The spin-off is carried out for profitable reasons. Any loss in the past can be addressed by not incurring any new losses. | The Profit or the loss for a subsidiary belongs completely to it. It has a distinct advantage of the cash flow initially happens from the parent company. |
| Formation | Spin-off aides the formation of new subsidiaries. | The subsidiary has the advantage of forming a subsidiary under it too. |
| Tax Benefits | Spin-off gives complete tax benefit to the parent company by forming the subsidiary entity. | No such benefits are available for the subsidiaries. |
What is Spin-off?
A spin-off is a well thought corporate action where a parent company creates a subsidiary entity to take care of a certain part of the business. The shareholders of the parent company receive the shares of the new company as well.
In this way, the shareholders enjoy the benefit of holding both the companies’ shares. Spin-off gives rise to huge accountability and responsibility to the subsidiary entity.
There are many reasons for a spin-off; the main one is to give undivided attention to certain core operations. The other reasons are on the lines of scaling up the profit and addressing financial issues.
When a spin-off happens, the subsidiary takes a part of the assets from the parent company. In return, a pre-defined amount is paid to the parent company.
Once a spin-off happens, the subsidiary runs independently of the parent company with a new management team. But many times, the management team members are acquired from the parent company.
Spin-off offers a great advantage to the subsidiary as it is strongly backed by the parent company. It also gives rise to new ideas in an environment thereby making the subsidiary entity strong.
The parent company offers certain support to the subsidiary in the wake of the spin-off. Parent company invests equity, helps create cash flow, and also provide legal and financial advice.
What is Subsidiary?
A subsidiary is a company formed, owned, and controlled by the parent company. The subsidiary entity is a new firm that operates independently with its own identity.
The subsidiaries can be of different types. It can be a company or a corporation while sometimes they can be limited liability companies also.
Many multinational companies follow this procedure of forming a subsidiary for offering more focus to certain operations in the new entity. Subsidiary functions on its own with certain controls revolve under the parent company’s circle.
Subsidiaries are legal entities formed by the holding company for many reasons. The main purposes of forming a subsidiary are liability, taxation, and regulation of certain norms.
The subsidiaries are legally distinct divisions, but most of the time the operations complement the parent company’s goods or services. The legality distinction gives both companies the advantage of operating effectively in their respective roles.
It is good to be observed that, the parent company need not be a big company to start a subsidiary. It can be smaller than the subsidiary too.
The subsidiaries are not required to function in the same location as the parent company too. There are multiple levels of subsidiaries available; first tier, second tier, and third tier, these are companies started one below the other for many commercial reasons.
Main Differences Between Spin-off and Subsidiary
- The main difference between Spin-off and Subsidiary is, Spin-of is a corporate action that forms new subsidiaries that function independently of the parent company while the new shares are offered to the existing shareholders of the old parent company. The subsidiary is a new legal entity that is formed by the parent company to focus on key areas of operations that the parent company requires.
- The benefits of a spin-off are on the taxation grounds and also can address a few financial issues, while Subsidiary has a distinct advantage of functioning independently with its own identity.
- Spin-off indeed is carried out for profitable reasons only. The parent company shall not suffer any loss by spin-off while the profit or loss of the subsidiary also does not impact the parent company.
- Spin-off forms subsidiaries while subsidiary can also form subsidiaries under them as second-tier and third-tier subsidiaries.
- The tax benefit is available for the parent company at the event of spin-off while there are no such tax benefits for the subsidiaries.
Conclusion
The action taken to create new subsidiaries is always welcome. This gives a distinct advantage to the shareholders. One, they have shares of both the companies. Two, if the new entity picks up, the value of the shares rises.
In another way, giving rise to subsidiaries offers the employees a new environment to work. This will improve productivity too. More importantly, the key areas to be focused which the parent company missed out earlier can happen effectively now.
Subsidiaries start functioning independently and it creates a risk-free environment too. The loss in the subsidiary will not affect the parent company.
References
- https://onlinelibrary.wiley.com/doi/abs/10.1002/smj.4250130604
- https://krannert.purdue.edu/faculty/mcconnell/publications/PublicationsPDFS/Can…Gains%20JFQA%20Dec1995%20V30%20N4%20465-485.pdf