Delaware holding companies were created due to the state income tax law, which allowed foreign firms (those not established in the state of Delaware) to be largely tax-exempt.
According to Delaware’s tax rules, corporations that only conduct business within its borders in order to maintain and manage their investments, intangible property, or trusts that have registered as investment companies under the Investment Company Act of 1940 are exempt from paying corporate taxes. Due to this special tax treatment for these kinds of enterprises, companies started forming holding companies—sort of tax-exempt boxes—in Delaware to keep their intangible assets. These investments or intangible assets include things like:
- Stocks
- Patents
- Bonds
- Notes
- Patent applications
- Trademarks
- Trade names
Delaware holding companies are widely utilized to hold various kinds of investments as well as intellectual property. These businesses are subsidiaries of bigger businesses that are the legal owners of all the assets kept there. For access to those assets, the parent business obtains licenses, and as a result, the subsidiary company receives royalties. Tax deductions are available for the licensing fees paid. Therefore, using a holding company doesn’t significantly increase the cost of the parent business’s operations.
TYPES OF DELAWARE HOLDING COMPANIES
- Investment holding company – A company that only exists to hold investments and possess stock in other businesses. Dividends, interest, and capital gains are the main sources of income for investment holding companies.
- Intellectual property holding company – Patents, trademarks, and other forms of intellectual property are owned by an intellectual property holding firm. These properties are used to generate income through licensing and other types of royalty payments.
- Management holding company – This is a firm that controls the operations of one or more subsidiaries. Due to its capacity to lower taxes and minimize liabilities for corporations, this sort of holding company is popular in Delaware.
USES OF A DELAWARE HOLDING COMPANY
Using a holding company to centralize a multi-divisional company
- If the applicant is in charge of a business that produces and sells a variety of consumer goods, such as toothpaste, vitamins, and laundry detergent.
- They can organize their firm under one holding company with numerous subsidiaries rather than creating a single organization with various divisions. Each product division might function as a separate subsidiary that the parent company controls. This is regarded as a fantastic approach to centralizing the business’s operations, improving administrative effectiveness, and perhaps even attracting new investors.
Holding firm for intellectual property (IP holding company)
A holding corporation can be used to hold several patents, trademarks, or copyrights that the applicant wants to manage, sell, or license to other parties. By doing this, they can make use of their intellectual property rights while protecting them from operational risks, legal action, and potential creditors.
REQUIREMENTS FOR FORMING A DELAWARE HOLDING COMPANY
The applicant must fulfill all the conditions listed below in order to establish a holding corporation in Delaware:
- avoiding any activities other than those necessary to safeguard and manage intangible assets
- maintaining sufficient capital to support operations
- not acquiring any property that is not necessary for the management of intangible assets
- keeping separate records and bank accounts
- submitting annual tax returns
- Keeping up with all due payments, filings, and fees
HOW TO FORM A DELAWARE HOLDING COMPANY
Choosing a suitable business structure
The applicant should choose the business structure that works best for them after taking into account a variety of aspects, including the nature of their enterprise, the requirement for asset protection, limitations on liability, and tax implications.
Submitting the documents
- After deciding on the organizational structure, the applicant must submit the required papers.
- They must submit a Delaware Certificate of Incorporation for a corporation, whereas an LLC needs to submit a Certificate of Formation.
- The documentation will be examined by the Delaware Division of Corporations to make sure it is accurate and compliant with Delaware law. The applicant will get a stamped Certificate of Formation/Incorporation once it has been authorized, confirming the fact that the business has been formally established in Delaware.
Refer to Delaware company incorporation if you wish to know more about forming an LLC in Delaware.
ADVANTAGES OF A DELAWARE HOLDING COMPANY
Taxation
- A Delaware holding company is a useful instrument for avoiding state taxation of passive income, saving the business a lot of money on state taxes each year.
- Corporate entities in Delaware that only handle the intangible assets of other corporations or business trusts that are registered as investment companies under the Investment Company Act of 1940 are exempt from taxation under Delaware’s corporate income tax laws.
- These investments or tangible property that is physically located outside of this State are similarly exempt from the collection and distribution of income.
Low costs
- The management of the assets will be easier and more cost-effective if the holding company owns the entire portfolio of assets. Furthermore, if the company is sold, it will be simpler to allow the transfer of property rights and assets.
- Commercially speaking, it might make sense to retain ownership of the intellectual property rights after selling the business and provide the new owner with a license to do so in order to continue earning money (without putting in a lot of extra work).
Asset protection
- Assets kept in a holding company might offer excellent protection. In the event that the company faces the possibility of going bankrupt, an asset that is controlled by the holding company is likely to be beyond the reach of creditors.
- This is very important if the company is new and there is a greater likelihood of disruption. In order to thrive in business ventures, the holding company can also license the assets and property rights, assuring business continuity.
Access to funding
- Compared to operating companies and subsidiaries, a holding company usually has a stronger financial standing and can borrow money at a lower interest rate.
- Delaware holding companies can make it simpler for the applicant to obtain capital from investors if they work in high-risk sectors like cryptocurrencies, insurance, or construction. As opposed to a single company with the same high-risk profile, banks are more likely to lend money to a group of enterprises with diverse industries.
CHALLENGES OF A DELAWARE HOLDING COMPANY
Insufficient managerial skills
The applicant might not be familiar enough with each type of asset and property that their holding company controls because it controls a wide range of assets. The overall management of the business could suffer as a result, and they might not be able to decide how to allocate the resources most effectively or react to market and competitive conditions.
Management difficulties
- The use of holding corporations brings a level of complexity that is absent in the single-entity structure, which makes monitoring and controlling all aspects of the firm more challenging because there are multiple subsidiaries to keep track of.
- It could be difficult for the applicant to maintain the ideal ratio of control to autonomy with their subsidiaries. While excessive centralization may inhibit innovation, decentralization can lead to a lack of cooperation across the firms.
Increasing complexity
- It may be necessary to consolidate the financial accounts of the subsidiaries if the firm is structured as a holding company, which might complicate business operations, particularly in the area of financial reporting.
- This can make it more challenging for creditors and investors to comprehend the financial health and success of the company. To manage the affairs and comply with rules, the applicant might need to bring on board extra staff members like accountants and attorneys.
Reach out to us at Relin Consultants – Leading Global Business Set Up Partners for further assistance with your Delaware company formation.
FAQs
Why form Delaware holding companies?
The Delaware General Corporation Law benefits corporations and shareholders the most. Delaware’s corporation legislation is continuously changing to meet the demands of contemporary firms, and the state has a long history of being business-friendly.
Which states permit holding corporations?
Businesses can form holding companies in Delaware, Nevada, and Wyoming.
Can a holding company be an S corporation?
S-corp (S corporation) is a type of federal tax identification rather than a recognized organizational structure. This implies that in order to qualify for S-corp status, your holding firm must first be registered as a corporation or an LLC and must follow certain requirements set forth by the Internal Revenue Service (IRS). You cannot just choose to incorporate your holding business as an S corp.
What distinguishes an LLC from a holding company?
An LLC is a type of company that shields its owners from personal liability. A holding corporation is a business that receives all of its revenue from passive economic activity.
An LLC indicates a legal corporate structure, whereas holding refers to a company’s status, defining the nature and primary activity of the business.
Although it’s not a requirement, holding companies can be set up as LLCs.
What advantages do Delaware holding companies offer?
One of a holding company’s biggest benefits is its capacity to exert control over a number of businesses. Liability defense is provided in this particular case to the parent corporation. This is due to the fact that each subsidiary is regarded as a separate independent entity.
What tax benefits does a holding company provide?
A holding company has tax benefits, such as the elimination of the need to file separate tax returns for each holding company. A limited liability company, parent corporation, or limited partnership that holds enough voting shares in another company to influence policy and management is referred to as a holding company.
