At first glance a tempting idea for many entrepreneurs: to control several companies under one holding. But is it really that simple?
In addition to many advantages of forming a holding, this also bears risks that the owner will have to bear in mind. In this post, I will discuss whether these risks outweigh the advantages, or whether the formation of a holding makes sense for you.
What exactly is a holding?
A holding (often also referred to as “parent company”) can be a partnership or a corporation holding shares in other corporations. These are commonly referred to as “subsidiaries”.
With regard to the parent-child relationship of a holding, we differentiate between four different models:
- The financial holding
This type of holding is defined by its interest in the subsidiaries under its wing. The financial holding company exerts no influence on the management of its subsidiaries but merely exercises its rights as a shareholder (e.g. at general meetings, in drafting the articles of association etc.).
- The management holding
The management holding, on the other hand, has at least a bare majority in its subsidiaries and is therefore in charge. The subsidiaries are dependent on such type of holding, and the holding is also responsible for their management.
- A holding that performs services for its subsidiaries
There are also holdings that provide services for their subsidiaries. The holding may for example take over bookkeeping, consulting etc. for individual subsidiaries.
- A holding with its own business activities
In addition to these services provided to subsidiaries, the holding company can also have its own business activities. For example: one subsidiary produces cars, the other navigation systems. The holding itself, however, produces tires. Neither the businesses of the two subsidiaries nor the business of the holding company are directly related to each other. All three companies could also maintain their business activities independently from the business activities of the others. Nevertheless, the role of the holding is to manage the joint profits and losses in the best interest of the entire group of companies.
6 potential advantages of a holding
If you already own more than one limited liability company (or hold the majority interest) as owner or managing director, forming a holding may be worthwhile. This will bring you 6 useful advantages, serving to improve the profitability of your companies:
Advantage #1: 95% tax-free profit distributions
A holding is often formed for tax reasons. The reason behind this is that 95% of the profit distributions of subsidiaries is transferred to the holding free of tax. This applies to all holdings without a profit and loss transfer agreement.
If, however, a profit and loss transfer agreement is in place, the profits of a subsidiary initially go to the holding company 100% free of tax. The holding takes on the responsibility for taxation and offsets profits with any losses that might have occurred in the group of companies.
Please note: The profit and loss transfer agreement may sound tempting, but it can also lead to problems. If a subsidiary is in financial difficulties, for example, its losses may put the parent company at risk (due to offsetting these losses against other profits).
The holding company automatically assumes the role of tax debtor for the revenue of the entire group.
Advantage #2: Joint taxation of all profits and losses
However, if you are aware of the latter risk for the parent company and manage your group of companies cautiously from a risk perspective, you could benefit from a tax advantage. That means: all profits and losses of the subsidiaries are netted before any tax is deducted.
For example: Ltd. A generates a profit of EUR 100,000, and Ltd. B generates a loss of EUR 100,000. If the two companies were taxed separately, Ltd. A would have to pay taxes. Merely Ltd. B would not pay any taxes as it made a loss. However, if there is a holding Ltd. C that owns 100% of each company, the profit of Ltd. A and the loss of Ltd. B are netted, and no taxes are due in total.
A formation of a holding thus has the advantage that the profits and losses of the individual companies are no longer viewed in isolation.
Advantage #3: Asset building instead of profit distribution
This advantage is related to the retention of profits. The concept is easier than it sounds: retention means that profits are not distributed at the end of the financial year, but remain within the company. Therefore, the formation of a holding enables you as the owner to develop new strategies for asset building in your group of companies.
Advantage #4: Separation of risks
By forming a holding, you are in a position to distribute the risks related to certain business operations across several subsidiaries. This mitigates risks across the group. If you only had one company with several departments, a single department that generates losses could drag the other departments with it into financial problems.
In the holding structure, the other companies are not affected by financial difficulties of one of the subsidiaries. And yet, all profits and losses of the subsidiaries are netted in one gross asset value (GAV).
Advantage #5: Enhanced public image
The formation of a holding enhances the public image of your group of companies for you as the owner or managing director. This way, all your subsidiaries can benefit from the positive public image of the holding company.
Advantage #6: Preventing a hidden profit distribution
The holding maintains an overview of all subsidiaries. This way, tax risks – such as hidden profit distribution – can be minimized. As the owner of the holding, you can distribute 95% of the profits of all limited liability companies free of tax, use it to offset the losses of individual subsidiaries etc.
Risk: parent-child dependency
Having listed so many advantages of a holding, I must now also draw your attention to its risks. The biggest disadvantage of a holding is the dependence of its subsidiaries.
In other words: if the continued existence of your holding company is ever threatened, the subsidiaries will share its fate. Even if the other limited liability companies generate high profits and are well positioned in the market, they will go under if the parent goes under.
In the case of several sister companies that do not belong to the same tax group, in contrast to the holding structure not all limited liability companies would automatically be affected if one of them goes into financial difficulties.
Further risks arise during the formation and management of a holding
These 5 points must be taken into account when founding a holding:
- Five-year minimum execution period for the profit and loss transfer agreements
- Legal uncertainties in the event of errors with regard to the application of law
- No utilization of losses carried forward
- Fiscal unity in the tax group may be lost because of accounting errors
- Incorrect computation of majorities
Conclusion: forming a holding always makes sense for owners of several limited liability companies
If you own several limited liability companies, you will benefit from both tax and administrative advantages by forming a holding company. For you as the owner it is important, however, that no major errors occur. After all, if the continued existence of your holding is under threat, this will also affect equally your other corporations.
My recommendation is therefore to carefully weigh up the advantages and disadvantages of a holding structure before you set it up. For this purpose, you should consult your tax adviser in Hamburg to calculate all possible scenarios.
If you have any further questions regarding the formation of a holding or would like my advice, please feel free to contact me by phone (+49 40 44 33 11), e-mail (email@example.com) or contact form.
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