In fact, it was the Joint Stock Companies Act 1856 that first codified the idea of a simple company registration procedure and limited liability; it was the first piece of ‘modern’ company law.

But beyond the ‘standard’ company, there also is the concept of a holding company, an entity created 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 practical meaning of this is that a holding company has its own legal identity.

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 details 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 – this would not be the case if everything was operated within a single company.

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”.

And there is logic in this as it allows the building of a diversified group of companies that effectively have an insolvency firewall between each.

Another allied benefit of a holding company is pointed out by Smith – that 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 (compared to a sole trader or partnership). 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 Smith 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”. If this is the case, then profits can be relieved by using losses in other group companies; this would not be possible if an individual owned the shares in the companies separately. 

It is also possible to take advantage of this even if all the trade is carried out through just one of the subsidiaries. In this situation Smith says that only one set of accounts for filing purposes will needed for Companies House, but the company’s tax computation will require all the income and costs to be separated and allocated to each trade. 

It should be remembered that where a holding company does not trade, its sole purpose is to hold the assets of the group and income is likely to be generated from leasing assets to the subsidiary companies. In this situation Allender says that corporation tax will be payable on profits made. Thankfully, he says that “overall, there is no additional corporation tax exposure to the group as although the income in the holding company will be subject to corporation tax, the corresponding expense in the subsidiary companies will be deducted to reduce its corporation tax liability.”

Of course, if the holding company does trade, 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.

And for shareholders of holding companies, they are remunerated just like any other company – by way of dividends. Here Allender explains that on the basis that the holding company not trading in its own right, “such dividends are likely funded by the distributable reserves of the trading subsidiaries... dividends paid from subsidiary companies to the holding company are not taxed on the basis that both companies are UK resident”.

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.

Cost implications

It’s not irrational to expect that when a business operates through multiple entities, operational costs may increase. Indeed, Allender reckons that there may be administration and central services functions that are utilised by different businesses. However, he says that “these may sit naturally within a holding company, which then makes charges to the subsidiaries so that the costs are shared appropriately amongst them”.

Even so, as Smith says, “there will be some compliance costs as additional companies will need to be formed and additional accounts and tax returns will need to be filed”.

But he notes that these additional costs may not be as high as may be anticipated; accounting costs should not necessarily double when operating two trades from two companies rather than two trades from a single company. However, he says that “the company’s accountants would need to review all the income and costs of both trades individually regardless of whether they operate out of a single limited company or two”. Interestingly, he says that if a business grows and additional trades are started, “it could become unnecessarily complex to operate out of a single company”.

Smith also points out that there are what is known as ‘transfer pricing rules’ that apply to some larger companies. In simple terms, this means that “income and costs need to be apportioned between group companies on a fair, arm’s-length basis”. These rules are in place to prevent exploitation of the UK tax system and can be highly complex. Thankfully, Smith says that there is often an exemption for small and medium-sized groups to these rules. Small for these purposes, by the way, means having fewer than 250 employees and either less than €50m (euros) annual turnover or €43m (euros) balance sheet total – and yes, HMRC does still use euros to define companies by size.

Notably, there are no specific tax obligations and duties placed on a holding company that aren’t placed on ‘standard’ companies. Similarly, neither HMRC or Companies House have any views, or specific oversight or problems with holding companies other than general compliance.

Seek advice

But what if there is an existing company – how would the process of forming a holding company work? Smith, in answer 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.

Allender explains further. He says that “HMRC clearance isn’t mandatory, but at Shorts we highly recommend it to clients”. Here he says that applications need to be prepared in a set format and pre-determined by HMRC which tends to take up to 30 days to respond to a request. Applications include information such as details of the companies involved, a detailed overview of the proposed transaction and the motive.

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”.

Size doesn’t matter

With the scene set, it’s fair to pose the question – does size matter? Are holding companies only for large corporates?

In short, no. As Smith comments: “Contrary to what some might expect, size is irrelevant as many small and large groups of companies can have a holding company structure. It’s just that larger groups tend to have more and larger trading subsidiaries.”

And Allender agrees. He thinks that holding companies can be beneficial for all business sizes: “As risk management and asset protection are usually the main drivers for implementing a holding company, they generally apply to companies with substantial assets or large amounts of excess cash.” He advises that if there is a situation where the directors are wanting to bring together separate companies to form a group structure, regardless of their size, a holding company could be the way forward.

Summary

So, there it is. 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.