The Benefits of Establishing a Holding Company
Written by Jim Sanderson
In past issues, I have offered a variety of strategies to maximize your return on the time and money you have invested to make your business a success.
These strategies are found in such articles as The Value of Succession Planning (January/February 2012); Why Diversification Can Reduce Risk (September/October 2011); The Value of Professional Advice (May/June 2011); Long-term Planning (January/February 2011); Benefits of an Estate Freeze (September/October 2010) and Succession Planning (March/April 2010). I want to thank those individuals who enjoyed those articles and then contacted me for more information on their specific situation.
In continuing the theme of maximizing the return on your hard work over the years, I’ll now describe the benefits and potential pitfalls of creating a holding company. I’ll begin by addressing Tim Cestnick’s statement in his June 2009 Globe and Mail article that holding companies offer many benefits but add complexity to your life.
However, when you follow informed advice and have a well-thought-out succession plan, holding companies may provide you with welcome tax savings and help you reach your estate planning goals, to name just a few benefits.
What is a holding company?
A holding company owns shares in another company. When the holding company owns the majority of shares of another company, it is also referred to as the parent company. It generally does not produce goods or services itself; business owners usually create holdcos to own shares in another company. Owners may create holdcos to operate for a short period of time or as part of a long-term plan.
Minimal exposure to risk
Holdcos may protect a business owner’s interests by minimizing exposure to risk and by protecting the company from creditors while allowing the owner to enjoy the benefits of the operating company’s goodwill.
Under certain conditions, you can transfer cash from your operating company to a holding company tax-free.
Business owners can use the operating company to take risks rather than expose the holding company to potential uncertainty. This is because the holding company does not conduct transactions and therefore does not transfer cash or other assets. If a holding company lends money to the operating company, that borrowing company can become a secured creditor of the holding company. This ensures the holding company is at the front of the line when debt repayment is required or scheduled.
Based on the number of outstanding shares the holding company controls in the operating company, the dividends paid to the holding company may be tax-free.
When shareholders are faced with a high marginal tax rate, they may defer a portion of tax on dividends from taxable Canadian companies until dividends are paid by the holding company to the shareholders.
To further enhance your tax management strategy, you may be able to set up the holding company in a province with a low corporate tax rate.
A holding company may also help smooth the transfer of wealth to the next generation. For example, you may be able to transfer shares in an operating company to your children through a holding company using an estate freeze.
Estate freezes essentially put a ceiling on a person’s tax liability upon his or her death and transfer any future cash gains within the operating company to his or her beneficiaries.
Creating a holding company can be expensive, as you must provide annual financial statements and corporate tax returns. If your shares are not of significant value, a holding company may create more headaches than peace of mind.
Tax benefits may not exist, or worse, tax problems may arise
It is important to remember that any losses realized in a corporation are only available to offset other income earned by the corporation.
And, the $750,000 capital gains deduction does not apply to holding companies.
A holding company may trigger an additional level of tax in addition to any personal income tax on distributions from the holding company. This is due to taxable income earned by the holding company and could lead to double taxation of the underlying income.
You will need to consider tax-efficient ways to distribute assets from a holding company to shareholders to avoid a negative tax event, a process that can take time and money.
A successful holdco in action
Gord is a business owner who established a holding company (Holdco) several years ago. Holdco owns all the shares of Gord’s operating company (Opco), which he started three decades ago to distribute construction safety equipment.
Each year, Gord pays part of the earnings of Opco to Holdco in the form of a dividend – tax-free. Gord invests the proceeds in securities, his son’s ski resort and other business opportunities. When Opco needs more money to invest or spend, Gord takes money from Holdco and lends it to Opco. He pays Holdco income to himself, and other family members, annually.
Under this arrangement, Gord enjoys a number of benefits:
As Opco creates excess earnings each year, Gord pays Holdco in the form of a tax-free dividend, which shields that money from any Opco creditors.
In Gord’s situation, dividends paid by Opco to Holdco are generally tax-free.
Tax-efficient reinvestment. By reinvesting some of Opco’s excess earnings elsewhere, Gord has diversified his assets. He pays tax-free dividends from Opco to Holdco and then makes those other investments through Holdco. If he paid the excess earnings from Opco to himself and then invested, he would pay tax first, leaving less to reinvest. This way, that layer of tax is removed, making reinvestment through Holdco tax efficient.
By paying income to his wife and younger children each year, some of the earnings are taxed in their hands, not his. Since his young children aren’t yet wage earners, the income he pays to them is not taxable. Dividends he pays to them (through his trust) are taxed at the highest marginal tax rate. When they reach 18, they are eligible to receive up to approximately $40,000 (depending on the province they live in) each year in Canadian dividends on a tax-free basis.
As I suggested at the beginning of this article, a holding company can offer many advantages, but it can make life complicated. Regardless of your situation, you are well advised to learn more by speaking with your tax professional.
Jim Sanderson is a wealth advisor with 25 years in the investment services industry. The Jim Sanderson Group at Scotia McLeod specializes in creating and distributing wealth for successful individuals and corporations in the aggregate and road building industries across Canada. He helps his clients supported by a team of experts in insurance, merchant banking, trust and estates. Jim can be reached at
and his website is www.jimsandersongroup.com.