The parent company can significantly shed its tax liability and reap benefits of deductions that would have been otherwise inaccessible without the formation of the subsidiary.
This provision is mainly provided for tax purposes.
The controlling corporation can increase their tax basis of the purchase to make that equal to the fair market value of their assets, by having their purchase considered as an asset acquisition instead of a qualified stock purchase.
Certain routine developments can trigger the need for a subsidiary.
Often, says CPA and tax attorney Mike Farra at Miami-based CPA firm Morrison, Brown, Argiz & Co., it will be the launch of a new venture that has different risk characteristics than the company’s existing line of business or the opening of operations in a new state or foreign country.
In this case, the law provides them the authority to operate their wholly owned subsidiary.
This is because the subsidiary will be under the indirect control of the tax-exempt company.
Other times, companies need to form subsidiaries to facilitate the potential sale of part of the company.
FROM AN ACCOUNTING PERSPECTIVE, creating a subsidiary makes sense because it allows companies to enjoy substantial tax benefits and creditor protections.
At the time of filing consolidated tax return, both the parent company and its subsidiary is considered as one entity.
Therefore, in case of any losses made by the subsidiary, the parent company can cover that up through its profits and lower tax liability.
But those costs may be measured in as little as thousands of dollars for smaller companies, and even when costs are higher, they almost always are nominal compared with potential rewards from legal protections and tax benefits. In the acquisition year, the frame company generates a profit of million, while the wheel company posts a million loss.