Subsidiary vs. Affiliate: What's the Difference?

Subsidiary vs. Affiliate: An Overview

Depending on the level of ownership an entity has in a connected business, it may be termed as an affiliate, associate, or subsidiary of a parent company. In most cases, affiliate and associate are used synonymously to describe a company with a parent company that only possesses a stake of between 20 and 50% ownership of the company. A minority stake is ownership or interest of less than 50% of a company.

However, a subsidiary is a business whose parent company holds a majority stake (meaning they are a majority shareholder of 50% or more of all shares). Some subsidiaries are wholly owned, meaning the parent corporation owns 100% of the subsidiary.

As a majority shareholder, the parent company owns enough of the subsidiary to exercise majority control over it, making decisions such as appointing the board of directors or other important business decisions.

For example, Disney-ABC Television Group, a unit of The Walt Disney Company (DIS), is involved in a joint venture with Hearst Communications (a private company) called A+E Networks, an American broadcasting company. The Walt Disney Company also owns an 80% stake in ESPN, an American multinational basic cable sports channel (Heart Communications owns the remaining 20% stake). The Walt Disney Company also owns a 100% interest in the Disney Channel. So, in this scenario, A+E Networks, which is independently-run, is an affiliate company;ESPN is a subsidiary, and the Disney Channel is a wholly-owned subsidiary company.

A joint venture is one where both companies own 50% and so Disney and Hearst Communications both hold exactly 50% which is not enough to establish the control necessary for a subsidiary.

Subsidiary

A subsidiary typically becomes part of a parent company to provide the parent company with specific synergies, such as increased tax benefits, reduced regulation, diversified risk, or assets in the form of earnings, equipment, or property.

Usually, companies take ownership of subsidiaries to extend the range of their products and services beyond what would be expected from the parent company’s brand.

The purchase of an interest in a subsidiary differs from a merger because the parent company can acquire a controlling interest with a smaller investment.

Affiliate

An investment in an associate or affiliate company is one in which the acquiring company owns between 20 and 50% of the shares. This ownership of shares implies "significant influence'" which is the accounting term that states that a company should be accounted for under the equity method of accounting. This is in contrast with a subsidiary, where control is established and consolidation accounting is undertaken.

Affiliate groups may elect to file a consolidated tax return that combines all tax liability into a single return. To be included in the return, the affiliate must have a shared parent corporation (in addition to meeting other qualifying factors).

Before filing, each affiliate must agree to file a consolidated tax return. All parties are then required to file IRS Form 1122. The advantage of filing a consolidated tax return is that it may lessen the overall tax burden of the company because it ignores sales between members and allows the losses of one member to offset the profits of another. However, consolidated filings are highly complex and complicated and must be approached with care.

How Foreign Ownership Is Handled

In many instances of foreign direct investment (FDI), companies create subsidiaries and affiliates in host countries to prevent any negative stigma associated with foreign ownership or negative opinion associated with being owned by a controversial parent company. Generally, FDI occurs when a company acquires foreign business assets in a foreign company. In this way, owning an affiliate or subsidiary can allow a company to extend its market share into parts of the world which it otherwise would not have access to.

In the banking industry, affiliate and subsidiary banks are the most popular arrangements for foreign market entry. Although affiliate and subsidiary banks must follow the host country's banking regulations, this type of corporate structure allows for these banking offices to underwrite securities.

While Bank of America still generates the majority of its revenue in its domestic market in the U.S., its acquisition of Merrill Lynch allowed for it to establish international operations. For example, London-based Merrill Lynch International is one of Bank of America's (BAC) largest operating subsidiaries outside of the United States. Merrill Lynch International serves customers worldwide and offers wealth management, research, analysis, fixed income, investment strategies, financial planning, and advisory services.

Special Considerations

For liabilities, taxation, and regulation purposes, subsidiaries are distinct legal entities. However, parent companies are required to combine the financial statements of subsidiaries with their financial statements. Affiliate groups may elect to file a consolidated tax return that combines all tax liability into a single return. To be included in the return, the affiliate must have a shared parent corporation (in addition to meeting other qualifying factors).

Before filing, each affiliate must agree to file a consolidated tax return. All parties are then required to file IRS Form 1122. The advantage of filing a consolidated tax return is that it may lessen the overall tax burden of the company because it ignores sales between members and allows the losses of one member to offset the profits of another. However, consolidated filings are highly complex and complicated and must be approached with care.

The Bottom Line

The difference between an affiliate and a subsidiary is established by the degree of relationship they keep with their parent company. An affiliate is a business with a parent company that only possesses a stake of less than 50% ownership of the company. A subsidiary, on the other hand, is a business whose parent company is a majority shareholder, meaning it owns 50% or more of the subsidiary company.

Subsidiaries are separate legal entities from their parents, and therefore they are liable for their own taxes, liabilities, and governance.