How a holding company earns money: dividends, management fees and loans

A holding company usually earns money in four ways: dividends paid up by the companies it owns, management or service fees charged to them, interest on loans it has made to them, and gains when it sells a stake. Dividends and fees are the most common in practice. Each stream has its own tax treatment and its own paperwork, and which ones apply depends on the structure, the countries involved and what the companies agree between themselves.

This post describes the general model. It makes no claim about the income of any particular company, and it is not tax advice.

The cash flows in a holding structure

In the simplest structure, a holding company owns shares in one or more subsidiaries that run businesses. Money moves in two directions. Upward, the subsidiaries pay the holding company as dividends, fees or interest. Downward, the holding company may lend to a subsidiary, put in capital, or provide services that it charges for.

Every movement between the two sides is an intra-group transaction. These are the places where tax authorities look closely, because a price set between related companies can differ from the price unrelated parties would agree.

Dividends from subsidiaries

A dividend is a distribution of profit by a company to its shareholders. For a holding company it is often the main route to cash from a subsidiary.

In Hong Kong the tax treatment depends on where the dividend comes from. The Inland Revenue Department (IRD) profits tax page lists as excluded from assessable profits "dividends received from a corporation which is subject to Hong Kong Profits Tax". The page does not name subsidiaries, so the exemption applies only when the paying company is itself subject to Hong Kong profits tax. A dividend from a company that is not, or from a company in another country, falls under other rules. One of them is Hong Kong's foreign-sourced income exemption (FSIE) regime. The IRD says it covers interest, dividends and equity-interest disposal gains arising outside Hong Kong on or after 1 January 2023, and other disposal gains from 1 January 2024, when they are received in Hong Kong by a member of a multinational group. Such income is exempt only if the recipient meets conditions such as the economic substance and participation requirements. This post does not work through those tests.

Hong Kong profits tax on corporations is 16.5% at the standard rate. The same page sets out the two-tiered rates for the year of assessment 2018/19 onwards: 8.25% on assessable profits up to HK$2,000,000, and 16.5% on the part above that.

A simple example shows the point. Suppose a holding company receives a dividend from a subsidiary that is taxed in Hong Kong. Under the IRD exclusion, that dividend is not part of the holding company's assessable profits. If the subsidiary were not taxed in Hong Kong, the same dividend would need a separate check.

Management and service fees

A holding company that has staff, an office or specialist knowledge may charge its subsidiaries for services such as finance, legal work or administration. The fee is income to the holding company and a cost to the subsidiary.

The OECD Transfer Pricing Guidelines set the test. Under the arm's length principle, the question is whether an independent enterprise in comparable circumstances "would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity in-house for itself" (paragraph 7.6, 2022 edition). The Guidelines also say that "the mere description of a payment as, for example, 'management fees' should not be expected to be treated as prima facie evidence that such services have been rendered" (paragraph 7.18).

Two things follow. A fee needs a written agreement that says what is provided. And the company needs a record that the service actually happened: time records, reports, the people involved and the work they did. A fee with a label and nothing behind it is the weak point in a holding structure.

Intercompany loans and interest

A holding company may lend money to a subsidiary and charge interest. The interest is income to the lender and a cost to the borrower. The same arm's length logic applies: the rate and terms should be what unrelated parties would have agreed in similar circumstances. The OECD Guidelines set one standard for intra-group prices, and a loan rate is one of those prices. A loan at no interest, or at a rate far from market, can be questioned by a tax authority under that standard.

Keep the loan agreement, the interest calculation and the payment records. If the loan is not repaid on schedule, record that too.

Capital gains on selling a stake

When a holding company sells the shares of a subsidiary, the result is a gain on a capital asset. The IRD page says profits tax is chargeable on "all profits (excluding profits arising from the sale of capital assets)". A gain on a stake held as a capital asset is therefore generally outside the profits tax base in Hong Kong, with two caveats. The IRD page does not say how to tell a capital asset from trading stock, so check the IRD's guidance for the facts of a given case. And a gain on shares in a foreign entity can fall under the FSIE regime described above.

This is one reason holding structures are used for disposals. Selling a company can be simpler than selling its assets one by one, but the buyer and the seller each need to check the tax treatment in their own jurisdiction.

Documentation and transfer pricing basics

Whatever the income stream, the file should show three things: the agreement that sets the terms, the evidence that the transaction happened, and the calculation of the amount.

Dividends: the resolution that declared them, the accounts they were paid from, and the payment record.
Fees: the service agreement, and the time, activity or output records that show the work was done.
Loans: the loan agreement, the interest schedule and the repayment record.

These files matter because the OECD paragraph on management fees makes clear that a label on a payment is not enough: the records are what show the transaction took place. Where more than one country is involved, the same records may be needed in each.

A note on advice

This note describes the general model of holding company income. It is not legal, tax or accounting advice, and it does not say how any particular company is taxed. Rules differ by country and change over time. Anyone setting up or running a holding structure should ask a qualified tax adviser and an accountant in each country involved.

The what is a holding company post explains the basic terms, and can a holding company run a business takes up the question of whether the holding company itself trades. For how the group is organised, see what we do.