Understanding holding companies: what are the advantages?

by | Jan 29, 2024 | Business, Dividends, Limited company

When we are talking about corporate structures, the holding company assumes a pivotal role; you can think of this as a parent overseeing different subsidiary businesses. In this post the Freedom In Numbers accounting team uncover the intricacies of holding companies, shedding some light on their functions and scrutinising the associated benefits and disadvantages for this type of business. We will pay particular attention to their use in asset protection and, most importantly, their tax efficiency.

 

So, what actually is a holding company? 

A holding company, in essence, represents the core of a corporate family, a bit like a parent looking after their children. It is an autonomous parent entity exercising control over companies underneath it. They tend to focus on strategic decision-making for a broader corporate family and have control and ownership of a group of other companies that they sit on top of. It is often used in larger corporate structures.

Let’s look at the example of the Cadbury brand and how it fits within a holding company:

Explaining a holding company, an example

Cadbury was established in 1824 and is a famous UK based chocolatier, becoming one of the most iconic confectionery brands globally, mainly known for its Dairy Milk bar.

In 2010, Kraft Foods acquired Cadbury for £11.9 billion, amalgamating two high-profile food companies. Subsequently, Kraft Foods separated some international food brands, including Cadbury, under a holding company called Mondelez International.

Cadbury and other Mondelez brands contribute to the company’s leading global market share in the chocolate industry. Mondelez International, holding strong market share positions worldwide, ranks high in biscuit and confectionary sales across the globe, but faces tough competition from various companies such as Mars/Wrigley’s, Hershey, and Nestle.

Currently Cadburys sits within the holding company of Mondelez International, so Mondelez is the parent of Cadbury. Mondelez also owns many other brands which sit in their holding company structure, such as Oreo, the UK brand Halls and many more.

 

What are the advantages of holding companies?  

There are some great benefits to managing your business within the framework of a holding company, let’s take a look here:

 

Minimising risks and protecting your assets

A holding company essentially assumes the role of a safeguarding entity, protecting any high-value assets that a business has, such as property and capital, from potential risks from companies underneath it. So, let’s look at an example of where this is useful; if one of the companies in the group is at risk of insolvency due to turbulent market conditions, then it makes sense to have already transferred their assets into a holding company to offer some protection for these.

 

Group relief for company losses

Subsidiaries within a holding company structure can collectively offset trading and other losses. Although separate taxable entities, group companies benefit from special rules that enable a company with losses to surrender them to another in the same group, reducing the latter’s liability to corporation tax. However, conditions such as both companies being based in the UK and being part of the same group must be met first.

 

Dividend management and substantial shareholding exemption

The substantial shareholding exemption (SSE) is a tax benefit for companies based in the UK. It’s this rule that saves you from paying corporation tax on certain gains when a company sells shares that they have invested in another company. Even if the sale results in a loss, you’re in the clear – with no corporation tax due on this balance. The SSE is actually a bunch of exemptions rolled into one, and the best part is, it applies automatically. Also important to consider, when a subsidiary pays dividends to the holding company, those dividends are free from corporation tax. So, holding companies can make tax a lot easier when you’re selling shares or paying dividends.

 

Okay, but what is the downside to holding companies? 

Setting up a holding company brings some administrative burdens and challenges to managing your business within this framework:

 

Managing this complex structure

When the holding company oversees multiple trading subsidiaries, it naturally influences how things are run. This influence sometimes clashes with the plans of subsidiary managers and can create friction within the different groups about how each entity should operate. It is also important to remember that sorting out corporation tax payments depends on the overall profits within the whole corporate group.

 

Increased operational costs

Running a multi-layered holding company structure means more paperwork, more compliance, and, you guessed it, more costs in managing the operation. You’ll be dealing with more filings for Companies House and HMRC and a regulatory maze due to a complex corporate setup.

 

So, how do you actually build a holding company? 

Creating a holding company involves a particular process, often using a “share for share exchange.” This move ensures a smooth transition without hitting shareholders with the burden of capital gains tax. You need to submit a clearance request letter to HMRC to explain why your company is changing its structure. Crucially, maintaining consistent ownership proportions before and after the exchange is essential for the success of the change.

 

Holding companies, our final thoughts 

Before diving into the holding company world, checking how inheritance tax plays into the picture is smart. Take a good look at the inheritance tax situation for individual shareholders. It’s a crucial step that needs careful planning and consideration.

Holding companies offer a shield for assets and some tax benefits, but they come with increased complexity in their setup and management. To make the most of the perks and avoid the pitfalls, you need a solid grip on the administrative challenges and a clear management strategy; this way, you can take advantage of the reduction in risks and tax benefits.

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