German subsidiary explained: Structure, liability and ties to the holding company

What is a subsidiary company?

A subsidiary 💬Tochterunternehmen or Tochtergesellschaft is a company that is controlled by a parent company 💬Muttergesellschaft. There is no mandatory legal form for German subsidiaries, but in practice most are set up as a GmbH, UG, KG or AG.

Although subsidiaries are typically incorporated companies, some group structures also treat partnerships or even natural persons as subsidiaries if they are under the parent company’s control. The legal basis for determining control is set out in § 290(1) HGB.

How is a subsidiary structured?

From a legal standpoint, a subsidiary is an legally independent company that’s economically dependent on its parent. However, a subsidiary cannot exist without a parent to exercise control over it. This is done using a controlling agreement 💬Beherrschungsvertrag. It defines how the legal relationship between the parent company and the subsidiary is structured in concrete terms.

Furthermore, most subsidiaries use a profit transfer agreement 💬Gewinnabführungsvertrag. With this additional contract, the subsidiary defines the transfer of its profits to the controlling company. The controlled company operates in the interest of the controlling parent company.

The only exception where control remains with the subsidiary is a joint venture. For this, several companies form a cooperation.

Although a 10% share in the subsidiary already defines it as a controlled company, most subsidiaries are majority-owned by the parent company. If the parent company holds 100% of the shares, this is referred to as a wholly-owned subsidiary 💬hundertprozentige Tochtergesellschaft. This share distribution is the most common.

What is a spin-off?

When setting up a business, subsidiaries usually plays a minor role. So generally, a business plan rarely contains any information on expanding the corporate structure further down the road. This is because most founders don’t really think about the possibility at the very beginning.

Very few founders plan on forming a large group of parent companies and subsidiaries ahead of time. After a successful start-up, however, it often makes sense for a well-developed and large enterprise to transfer a certain portion of the company to a subsidiary—this process is referred to as spinning off 💬Ausgründung .

Understanding the lingo: Subsidiary vs. branch and permanent establishment

While the subsidiary is economically independent of the parent company, a branch 💬Niederlassung is classified as legally dependent. This is the decisive factor when differentiating from the subsidiary. Legally, a branch always remains part of the main branch, even if it acts as an independent company.

Another term that may be confused with a subsidiary is permanent establishment 💬 Betriebsstätte. A permanent establishment is an opportunity for companies that are not registered in the commercial register to expand their business, i.e. sole proprietors or civil law partnerships. A permanent establishment is largely dependent on the main company and cannot conduct business without it.

What’s a parent company?

A parent company is a legally independent entity that exercises controlling influence over at least one dependent entity. Further designations are parent corporation, parent group or top company. The controlling influence of the parent company is mostly based on equity interest 💬kapitalmäßige Beteiligung.

A parent company can take any legal form. In practice, stock companies and limited liability companies such as AGs, GmbHs and KGaAs are common choices, but partnerships can also act as parent companies if they hold a controlling interest—for example, through majority voting rights or a control agreement. What matters legally is control, not the legal form.

When a parent company controls one or more subsidiaries (and possibly further sub-subsidiaries), this forms a group of companies 💬Konzern. A group structure that revolves around a parent company holding shares in other entities is also commonly referred to as a holding company 💬Holding, although not every holding company is a legally defined Konzern.

In group structures, the parent company exercises strategic control, while the subsidiaries remain legally independent but operationally overseen by the parent. Subsidiaries may carry out day-to-day operations, specialise in particular business units, or hold specific assets within the overall group.

Legal relationship between subsidiaries & parent companies

In a nutshell, a subsidiary is legally autonomous but economically dependent on its parent company – however, the practical arrangements for this relationship between the two companies can vary considerably. Each holding company structure can, therefore, be defined individually.

The parent company itself can operate with the subsidiary or limit itself to administrative, coordinating and controlling activities. There are five main variants of the holding company:

• Operative Holding: The parent company itself is active in operations, and the subsidiaries are very strongly influenced by the parent company.
• Management Holding: Decision-making and controlling are defined by the parent company for all subsidiaries. This means that the parent company determines the strategic management or control of the capital flow within the holding company.
• Organisational Holding: The holding structure serves as the internal organisation, with subsidiaries each being responsible for a different business area.
• Financial Holding: This holding variant only serves for asset management purposes.
• Investment company: The parent company assumes the role of a shareholder, while the subsidiaries are responsible for day-to-day operations.

The transactions of parent companies and subsidiaries are balanced out in the course of consolidation in the consolidated financial statements. This means that receivables and payables between the companies are offset against each other. Learn here how to set up a holding company in Germany.

What is a fellow company?

A fellow company 💬Schwestergesellschaft is a company that has the same parent company as another and is located on the same level of hierarchy. In addition, fellow subsidiaries are linked by their capital, because both were founded using the capital of the parent company.

Why set up a subsidiary?

In Germany, the most common reason for establishing a subsidiary is saving on taxes on exit. Due to large tax savings, almost all the proceeds from the sale of the subsidiary can flow directly to the parent company. Read more about the tax advantages for the Holding in this article.

These are other common reasons to set up a subsidiary:

• Outsourcing affiliation: Existing activities are outsourced or expanded abroad.
• Coordinated affiliation: Existing capacities are expanded.

A subsidiary is often formed when the parent wants to expand its business and the new line of business no longer corresponds to its core business and/or the original company objective.

In larger group structures, individual areas of activity are often separated by the establishment of several subsidiaries. In this way, separate business units receive more transparency with clear responsibilities.

The purchase of a foreign company can also create a holding structure. With the acquisition, the new company will be aggregated into an existing group. In this way, your own market power can be increased and you can benefit from synergy effects.

Liability in group structures

1. Basic principle: separate legal entities

A parent company and its subsidiaries are legally independent. Under the separation principle, the parent company is not liable for the debts of the subsidiary, and the subsidiary is not liable for the parent’s liabilities. This separation applies regardless of how closely the companies are connected in a group structure.

2. What happens when a subsidiary encounters financial trouble?

If a subsidiary becomes insolvent or faces economic difficulties, these problems do not automatically affect the parent company.
The liability risk generally stays with the subsidiary itself.

However, German corporate law includes mechanisms designed to prevent abuse of limited liability—for example, in cases where
the parent company directs the subsidiary’s business in a way that harms its creditors. In such exceptional situations, courts may consider whether the parent company has acted improperly.

3. When can liability between group companies arise?

Although the separation principle is the default rule, liability may arise in specific cases, depending on:

• the legal forms of the companies involved
• contractual agreements, such as control or profit-transfer agreements
• financial flows, especially if funds are shifted in a way that harms creditors
• how the companies behave towards each other, e.g. if a subsidiary is managed as if it had no autonomy

These situations are rare and assessed individually under strict legal standards.

4. What if the parent company becomes insolvent?

A parent company can survive the insolvency of a subsidiary. The reverse is less likely: if the parent company becomes insolvent,
subsidiaries are often affected, especially if they depend on intra-group financing or centralised management functions.

5. Loss compensation and profit-transfer agreements

If a parent company and subsidiary conclude a control and profit-transfer agreement, the parent company is obliged to:

• absorb the subsidiary’s annual losses during the term of the agreement, and
• after the agreement ends, provide security to the subsidiary’s creditors for certain claims.

Outside of such agreements, the parent company generally has no obligation to compensate the subsidiary’s losses.

Any annual loss contribution by the subsidiary must also be offset by the parent company. Claims do not expire until ten years after termination of the control or profit transfer agreement. The key date is the deletion from the commercial register.

Subsidiary: Pros & cons