Subsidiary vs. Affiliate: What's the Difference?

Depending on the level of ownership an entity has in a connected business, they 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 whose parent only possesses a minority stake in the ownership of the company.

However, a subsidiary is a business whose parent holds a majority stake or is 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, Walt Disney Television, a portion of The Walt Disney Co.(DIS) owns an equally held joint venture with Hearst Communications, a private company, called A&E Television Networks. DIS owns an 80% stake in ESPN and a 100% interest in the Disney Channel. In this case, A&E Television Networks, which is independently run, is an affiliate company; ESPN is a subsidiary, and the Disney Channel is a wholly owned subsidiary company.

In a business setting, a subsidiary becomes part of a parent company to provide the parent 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 their range of 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 in that the parent corporation can acquire the controlling interest with a smaller investment. Additionally, stockholder approval is not required in the formation of a subsidiary as it would be in the event of a merger.

According to the Securities and Exchange Commission (SEC) in the context of corporate, securities and capital markets, an affiliate is "a person or entity directly or indirectly controlling, being controlled by, or under common control with" another person or entity. For example, executive officers, directors, large stockholders, subsidiaries, parent entities and sister companies are affiliates of other companies. Two entities may be affiliates if one owns less than a majority of voting stock in the other.

In many cases 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. In this way, owning an affiliate or subsidiary can allow a company to extend its market share into parts of the world to which it may not otherwise have access.

In the banking industry, affiliate and subsidiary banks are the most popular setups for foreign market entry. Although affiliate and subsidiary banks must follow the host country's banking regulations, these styles of banking offices allow banks to underwrite securities.

For example, London-based Merrill Lynch International is Bank of America's (BAC) largest operating subsidiary outside of the United States and was incorporated back in 1988.

For liabilities, taxation, and regulations 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 and meet other qualifying factors.

Before filing, each affiliate must agree and file IRS Form 1122. The combined group may lessen the overall tax burden by ignoring sales between members and allowing the losses of one member to offset the profits of another. Consolidated filings are complicated and must be approached with care.