Incorporating a holding company has potential tax and non-tax benefits that may be worth exploring for your business. Holding companies can be used to reduce tax, income split, or potentially protect your assets from creditors.
You may ask, what is a holding company? A holding company is a corporation that owns shares in another company or corporation. Typically, the holding company is positioned in between an individual shareholder and the operating company (the company where the active business takes place). The holding company would typically own the operating company’s voting shares and assets as well.
Tax Deferral and Minimization
Dividends from Canadian corporations can flow between associated companies on a tax-free basis. This would allow for potential tax minimization strategies through income splitting among adult family members. Adult family members can be made shareholders of the holding company, with classes of shares that are entitled to receive dividends, and income can be split in the most tax-efficient way possible for each family’s scenario.
The tax-free dividend between companies also allows for funds to accumulate within the holding company year-after-year for potential re-investment in assets, while potentially still qualifying for the small business deduction.
Lifetime Capital Gains Exemption of $800,000
If you decide to sell the shares of your operating company at any point, the shareholders can potentially benefit from the lifetime capital gains exemption up to $800,000. In order to qualify, the corporation needs to be a Qualified Small Business Corporation (QSBC).
In order for the operating company to qualify as for the capital gains exemption, it needs to meet certain tests set out by the CRA. One of the tests requires that the company must be a Canadian-controlled private corporation (CCPC) and at least 90% of the assets of the corporation must be used in active business in Canada.
As you can imagine, if a business generates significant amounts of cash that is not distributed to shareholders or re-invested in the operations of the company, it is very possible that the cash assets can accumulate and exceed 10% of the total assets of the business. This would potentially disqualify the company from being a QSBC. By moving excess cash to the holding company via a tax-free dividend, this potential problem is avoided.
Protecting Your Assets
While many people understand that incorporating a business will protect your personal assets from creditors or other liability issues that a business may encounter, they often overlook the fact that any assets held within the corporation are still potentially at risk.
As earnings accumulate year-after-year within the corporation, if they are not distributed from the operating company to the shareholders (whether the shareholders are individuals or a holding company) they can be a target for credits in the case of bankruptcy, or a target for litigators in the case of any potential lawsuit. As noted above, the assets can be distributed to individual shareholders of the operating company, however depending on the specific scenario of the shareholders, the tax consequences may be significant.
By consistently moving any excess funds from the operating company to the holding company via the tax-free dividend, the assets are thereby protected and beyond the reach of credits or litigators. Thus, it may make great sense for your business to separately hold assets within the holding company, including real estate assets, to protect them from any potential risks that the operating company may be exposed to.
For any questions regarding holding companies, or for help with incorporation of a holding company, please contact us.