Business owners, landlords, and investors often consider various structures to optimize their financial and tax situation. One popular strategy is the establishment of a holding company or holdco.
Understanding Holding Companies A holding company is a type of business entity that primarily exists to own stocks, real estate, interests in other companies, or other assets.
Unlike operating companies or opco’s that engage in business activities and generate business revenue, a holding company’s main purpose is to own and protect its holdings. The advantages of having a holding company can include tax benefits, asset protection, and improved succession planning.
Key Reasons to Set Up a Holding Company
1.Tax Deferral and Income Splitting
A holding company can offer significant tax deferral for owner managers. Instead of the earnings being distributed as personal dividends and being taxed personally before investing, corporate earnings can flow to a holding company as a tax-free dividend (assuming ownership in the operating company is greater than 10%).
This can result in 30%-45% more funds to be invested in the holding company compared to if those funds were paid as a personal dividend and invested. The holding company can also provide better personal tax planning since the shareholders of the holding company can decide when and how much money will be withdrawn from the holding company.
This will allow for the income tax to potentially be lower and smoothed out as the funds can be withdrawn on a gradual basis over time and potentially split with a spouse who might otherwise be subject to the Tax on Split Income (TOSI) rules prior to retirement.
2. Creditor protection
A holding company can be used to own assets such as land or a building that are essential for the operating company to use. By placing such assets into a holding company there is an added layer of protection against creditors and potential liabilities that might occur in the operating company.
Along with key assets, the operating company can flow excess retained earnings to the holding company as a tax-free dividend to help create some separation between those earnings and creditors. These funds may be meant for the owner manager’s retirement and not for use of by the opco.
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3. Lifetime capital gains exemption
Individuals who hold shares of a Canadian controlled private corporation (CCPC) can claim a lifetime capital gains exemption if those shares are sold, assuming the company meets certain criteria. One of those criteria is that the company needs to have at least 90% of its assets used in active business.
Excess cash or investments in the operating company may put it in jeopardy of meeting this criterion, so flowing excess cash out to the holding company will help ensure the operating company is eligible for the lifetime capital gains exemption. This will help to reduce the personal tax liability when a CCPC is sold.
4. More flexibility to sell a business
By having a holding company that owns assets such as land or a building, this may make it more attractive to buyers who are only interested in the operating side of the business. By only having to sell the operations, this lowers the initial capital outlay required and therefore increases the ease and ability to sell.
The holding company can continue to rent the land and building as required to the buyer or to someone else, or could be sold as an asset sale in the future after the operating company has been acquired.
In Conclusion
Establishing a holding company in Canada can offer numerous advantages, particularly in terms of asset protection, succession planning, and tax efficiency.
However, the decision to set up such a structure should be made with careful consideration of individual circumstances, business goals, and in consultation with tax professionals and legal advisors.
Understanding when and how to best utilize a holding company as part of your business strategy can lead to significant long-term benefits.
Contact us today to learn more about holding companies and how they can benefit your financial goals.
