Holding companies are businesses that exist to hold stock in other businesses. In the marketplace, holding companies can be crucial in helping to finance the operations of subsidiaries. However, a number of disadvantages can arise. Imprudent management decisions as well as strict federal regulations can create an unhealthy business environment that affects holding companies and the subsidiaries they own.
Partial Multiple Taxation
IRS rules regarding holding companies operating in the United States require these businesses to pay more in corporate taxes if they don't hold a certain percentage of voting power over their subsidiaries. A holding company and the subsidiary it owns are allowed to file consolidated taxes if the holding company owns 80 percent or more of the subsidiary's stock. If the holding company owns less than 80 percent, the holding company and subsidiary file separate taxes. Holding companies deduct from its taxes 80 percent of stock dividends received from a subsidiary if the holding company owns at least 20 percent of the stock; under 20 percent, holding companies can deduct 70 percent.
When a court orders the dissolution of a holding company because of rules violations, it can be very easy to dissolve that business if the relationship between the holding company and its subsidiary is not integral to the operation of the subsidiary. Enforced dissolution can take longer or even be prevented if the business operations of the parent holding company and the subsidiary are integrated through management or corporate partnership. The financial operations of bank holding companies can be used to align themselves with their subsidiaries. Holding company relationships between two completely unrelated businesses only require the sale of stock for dissolution, as was the case in the enforced dissolution of DuPont holdings of General Motors Corporation in the 1950s.
Multiple tiers of holding companies are sometimes created to leverage a small amount of equity into a subsidiary with large operating assets. These assets, however, are an expression of the debt taken on by the holding company; a business with $500,000 worth of operating assets can be leveraged through a holding company operating with $250,000 in equity if the remaining $250,000 can be financed through debt. Multiple tiers of holding companies can be created to finance a business with large operating expenses, but a failure to meet debt obligations at any level can cause a domino effect that has ramifications on all interrelated companies, possibly even causing business failure.
Federal Reserve Regulations
The U.S. Federal Reserve enforces much of the regulation pertaining to financial institutions in the United States, including laws that affect bank holding companies. Regulation Y of the Board of Governors of the Federal Reserve System prohibits bank holding companies from operating in such a way that works to the detriment of the subsidiary business; for instance, a holding company could not transfer problem assets, such as loans or other accounts in default, to the bank subsidiary. However, a holding company is free to purchase problem assets from its subsidiary as it increases the liquid resources of the subsidiary.