Do I Need a Holding Company?

  • March 16, 2020

Is a holding Company right for me? Do I need a holding company in Canada?

Let’s start with a simple question: What is a holding company?

Holding companies, ordinarily, do not run a business nor have active operations. They are instead used to ‘hold’ investments such as: shares in public companies, bonds, real estate or shares in other private companies.

Let’s take a step back…

The Canadian tax system is designed to be neutral, in theory. It should not favour or unfairly position taxpayers based on how they earn income (i.e. personally or through a corporation).  In reality, the system is not perfect and there is a tax cost to earning investment income through a corporation in all Canadian provinces. So why have one?

The benefits

  • Personal tax deferral – Tax deferral is simply the flexibility to control when and how much income you receive, and therefore have more control over your personal tax bill. 

    If you own a company, you can pay yourself via salary or dividends.  Either way, you will need to pay personal tax, leaving less money to spend or invest. You could, however, move the excess earnings to a holding company and defer paying personal tax until later, leaving you with more funds to spend or invest in the future. 

    If a business has multiple owners, there is a future benefit to allow individual flexibility, a holding company for each owner allows for discretion on when funds are extracted.
  • Creditor protection – If a creditor of your operating company decides to sue you, they could theoretically have access to all of your company’s assets.

    To protect against this, your excess cash or investments could be moved into a holding company and these assets would be safe from creditors.

    Your company needs the cash?  No problem – you can even structure creditor protection by lending the money back to your operating company on a secured basis and still maintain that protection.
  • Lifetime capital gains exemption (“LCGE”) – If you aim to eventually sell the shares of your business, a major tax benefit is to be able to claim the LCGE, which allows you to save up to $440k in taxes!

    If your operating company has investments at the time of sale, you could potentially lose on these savings.  Using a holding company to remove excess funds, or what accountants call “purify”, can help keep you onside with the criteria.

    Estate planning – A holding company can help facilitate transfer of assets or ownership of the business through what is called an estate freeze. 

    This allows a shareholder to lock-in or “freeze” the value of your shares at a point in time, and transfer future growth to another individual. 

    This exchange may be done without triggering any tax, and acts as a tax-deferral, so you can better plan for the taxes payable on eventual disposition (including a ‘deemed disposition’ which would happen on death).
  • Income splitting – You may be able to pay dividends to family members who are shareholders of your holding company dividends.  If your family members have little to no income, these dividends would be taxed at a lower rate rather than paying the dividends to yourself.

    In most circumstances, you can’t split income with family members who aren’t involved in your business or your children that haven’t reached the age of majority.  The restrictions are complicated and, if you do not properly consider these, you can end up paying more tax instead of less. 

    Your personal situation needs to be considered, so please consult with your tax advisor before using this strategy.

Sounds great, right?  But what are drawbacks?

  • Incorporation costs – To set up a holding company requires you to incorporate a new company, like that of your existing business. If you do it yourself, you may minimize the cost at the risk of doing it improperly. Doing it through professionals, however, will increase the cost to you.
  • Ongoing costs – There are legal fees to be paid for annual filings, or if you issue a dividend, as well as fees to have an accountant complete your year-end financial statements and corporate tax return.
  • Increased administrative burden – There will be an increased burden to keep on top of filings and remain in good standing with paperwork.  If you are against this, you may want to consider avoided the extra administrative burden.
  • Restricted use of losses – If you invest personally, any losses you incur may be used to offset capital gains which may reduce your tax bill. However, if you invest through a holding company, the losses are restricted there and can’t be used to offset against your personal income.
  • Higher taxes – Without careful planning, you may end up paying more taxes. There is a tax on investment income when you earn it through the corporation and another tax once it is ultimately paid to you as a dividend.  Ordinarily, this is higher than the personal tax you would pay had you originally earned that income personally.

… But I have already incorporated my business, what are my options?

No problem!  You can still take advantage of a holding company using a tax deferred ‘rollover’.  The premise behind a rollover is to transfer shares of your business held personally into a holding company on a tax-deferred basis. 

You should not try to perform a rollover if your tax experience is limited. Please consult a tax accountant or lawyer for more information.

Ask us about holding companies

There are a lot of factors to consider on when deciding to use a holding company.  If you’re still uncertain about whether this is right for you, our experienced team of professionals is here to assist with a free consultation.

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