Once an Australian subsidiary is incorporated, the first practical question is how it will be funded. Many groups treat this as a banking step: send the money, then sort out the paperwork later. For the Australian directors, though, the way a subsidiary is funded affects solvency, decision-making and their own exposure, and it is much easier to settle at the start.
Equity, a loan, or both
A parent can fund its Australian subsidiary by subscribing for shares, lending money, or a combination of the two.
Equity means the board resolves to issue shares, the shares are issued, the share register is updated and ASIC is notified within 28 days of the issue. Money contributed as equity is not repayable on demand. Returns come through dividends or capital reductions, both of which are subject to Corporations Act requirements. A dividend, for example, can only be paid if the requirements in section 254T are met, including sufficient assets relative to liabilities, fairness to shareholders as a whole and no material prejudice to the company's ability to pay its creditors.
A loan is more flexible and can be repaid, but it should be documented in a written agreement covering the amount, interest, repayment terms and whether it ranks behind other creditors. The terms should also be considered alongside the group's transfer pricing, thin capitalisation and withholding tax position, so the funding structure is best settled with tax advisers before money moves.
Many groups use both: modest share capital, with the balance as a loan.
Who approves the funding in the Australian company?
The funding arrangement is a transaction of the Australian company, not simply an instruction from the parent. The Australian directors owe their duties of care and diligence, good faith and acting in the company's best interests to that company (sections 180 and 181), wherever the parent is based. The board should therefore consider and approve the terms, and record in a resolution what it is agreeing to and why.
The parent has a role too
The parent should be clear about what it has actually approved and committed to provide. Internal budget approval is not necessarily the same thing as a binding commitment to fund the Australian subsidiary. Where the Australian board is relying on parent support, the documentation should align with the approvals and expectations on both sides.
Is the subsidiary solvent, and what is it relying on?
Many new subsidiaries run at a loss while the Australian business is built. Directors must not allow the company to incur debts when it is insolvent, or would become insolvent by doing so (section 588G). If solvency depends on the parent's continued funding, the directors need a reliable basis for saying so.
A verbal assurance or non-binding comfort letter may provide directors with limited comfort. A documented funding commitment setting out the amount, period and any conditions gives the board a much clearer basis for assessing the subsidiary's funding position, particularly alongside a cash-flow forecast that the board reviews regularly. In some circumstances, a holding company may itself face liability in connection with insolvent trading by its subsidiary under section 588V, which is another reason for the parent to be clear about the support it is providing.
Planning how money comes back out
It is worth deciding at the outset how funds are expected to return to the group. Loan repayments, dividends, service charges and capital reductions each follow different rules and have different tax consequences. Intercompany charges should reflect services actually provided. Recording the intended flow of funds now avoids having to unpick it later.
A short checklist
- Funding documentation in place before funds move.
- A board resolution approving it in the Australian company.
- Share issues recorded in the register and notified to ASIC within the applicable timeframe.
- A documented funding commitment if the subsidiary depends on parent support.
- Tax review (thin capitalisation, transfer pricing and withholding) with your advisers.
- Source-of-funds information ready for the Australian bank.
How we help
Reservoir Legal works with international groups and their advisers on establishing and operating Australian subsidiaries, including funding documentation, board processes and ongoing company governance. Resident director appointments are provided through Australian Resident Directors.
See also our guide to setting up in Australia and our article on resident director liability.