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HOW A HOLDING COMPANY WORKS

The use of a holding company can help a firm control risk across various business interests

Most are familiar with the idea of incorporating a business to create a separate trading entity that, among other things, will protect business owners and their personal assets should the company fail.

But beyond the ‘standard’ company, there also is the concept of a holding company – an entity whose primary business is to hold a controlling interest in other companies.

DEFINING A HOLDING COMPANY

As Rory Smith, a corporate and business tax manager at accountants Mercer & Hole, outlines, a holding company is usually a company limited by shares. He says that “often it does not provide goods or services to customers, though it can. Rather, holding companies hold the controlling shares in other companies which carry on the business.”

These other companies are generally referred to as subsidiaries and have a definition in law. The Companies Act 2006 says that “a company is a ‘subsidiary’ of another company, its ‘holding company’, if that other company holds the majority of the voting rights in it, or is a member (shareholder) of it and has the right to appoint or remove a majority of its board of directors, or is a member of it and controls alone, under an agreement with other members, a majority of the voting rights in that company.” THE POINT OF A HOLDING COMPANY

For Stephen Allender, a senior tax manager at Shorts, there are several practical reasons why holding companies are created.

The first he says is to reduce risk: “If a company undertakes multiple trades, or has separate investments such as property, then stripping these out into separate subsidiary companies under the common control of a holding company should be considered.” This is because under a group structure, the risk to the trade of the subsidiaries would be minimised should one part of the overall group perform poorly or become insolvent.

To this Smith adds another perspective – that “where a subsidiary becomes insolvent, creditors cannot usually target the holding company, unless it has provided guarantee in support of its trading subsidiary which is often the case in finance documents and lease agreements.”

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Another allied benefit of a holding company is pointed out by Smith – if an operating company fails, and the intellectual property or real estate is held by its holding company, “a layer of protection for the holding company shareholders is provided as a potentially valuable asset is often beyond the reach of the creditors of the operating subsidiary.”

But as Allender comments, this protection can also be applied to “other assets such as trading or investment property, plant and machinery and excess cash to allow for investments.” Operating this way means that subsidiaries take on the daily operations of the business and its trading responsibilities, but assets can be leased to subsidiaries and are protected from creditors and general inherent risks that are associated with trading companies.

THE MATTER OF TAX

Those running a company will be aware of the potential for tax planning with a corporate entity. A similar potential applies to holding companies. Here, Smith highlights the benefit of group relief where losses can be transferred between companies in the same group. But he says that for this to apply, “one company must be at least a 75% owned subsidiary of the other, or they must both be at least 75% owned subsidiaries of another company in the same group.”

Where the holding company trades, then it will have corporation tax obligations like any other company. Furthermore, Allender says that quarterly instalment payments are payable by companies that have taxable profits in excess of £1.5m during an accounting period. And if a company has any related 51% group companies – where it is 51% owned by, say, a holding company – the £1.5m threshold is reduced by dividing the annual rate by the number of related group companies. “This,” says Allender, “needs to be considered as it could accelerate the corporation tax payable by the trading company.”

Moving on to dividends, Allender points out that they “can pass between subsidiary companies and the holding company without incurring tax charges.” Even better, he tells how tax exemptions available mean that where a company owns more than 10% of the shares in another company, and sells those shares, there will usually be no tax to pay on any gains arising.

But when it comes to transferring land and property, Smith says that it may be possible to transfer real estate between group companies without triggering an immediate Stamp Duty Land Tax (SDLT) charge as there is stamp duty relief for intra-group transfers. He warns, however, that “for SDLT purposes the definition of a group is more restricted and there is significant anti-avoidance legislation.”

There’s also the matter of VAT. Here Smith says “it is possible to form a VAT group where the companies are in a holding company and subsidiary relationship and thus supplies of services between each company in the VAT group does not attract VAT.” But there is a downside of this arrangement – all members of the same VAT group will be jointly liable for any debt due to HMRC which can defeat one of the objects of creating a holding company in the first place.

A layer of protection for the holding company shareholders is provided as a potentially valuable asset is often beyond the reach of the creditors of the operating subsidiary

SEEK ADVICE

But what if there is an existing company – how does the process of forming a holding company work? Smith says that “it would be usual to incorporate the holding company and for it then to acquire the existing company by way of a share for share exchange.” This, he adds, requires bespoke tax advice and usually advance tax clearances from HMRC. In most instances with planning, it can be carried out without a tax charge.

For both Allender and Smith the main reason for undertaking clearance is to protect shareholders against claims from HMRC that the transaction was set up to avoid tax. As such, HMRC will be looking at the motive for the transaction to determine that it is being undertaken for bona fide commercial reasons.

As for the risks of not seeking clearance, Allender highlights the chance that HMRC can deny relief under the share for share rules, “which would effectively create a capital gains tax charge on the shareholders based on the value of the shares held. Furthermore, there is a risk that HMRC could make a counteraction that the transaction falls within the transaction in security rules, which can effectively give rise to an income tax charge to the shareholders on the value of the shares.”

SUMMARY

Holding companies aren’t just for multinational firms, they are perfectly at home in the world of SMEs. However, the reasons for setting one up must be clear and good advice is necessary if one is to be set up – if only to keep HMRC happy. 

Rory Smith, a corporate and business tax manager at Mercer & Hole

Stephen Allender, a senior tax manager at Shorts