What is a holding company?
A holding company is simply a corporation that does nothing but own a controlling interest (shares) of one or more other companies that are actually carrying on business. The operating businesses pay dividends to the holding company. The key purpose of a holding company is to place a corporate entity between your income-generating business and you to protect the business’s earnings.
What are the benefits of a holding company?
Business owners set up holding companies for a number of different reasons:
- Tax deferral. Tax may be deferred when dividends are paid into the holding company rather than to individual shareholders.
- Income splitting. Dividend income can be distributed among family shareholders who may have different tax situations. Each can then proceed in the manner most advantageous to them in terms of taxation.
- Creditor protection. Every business faces some risk. Having a holding company adds a measure of protection for your operating business’s assets because you can transfer earnings to the holding company, where they can be invested and may be safer from creditors. The key is to get the holding company structure in place while everything’s going well with your company because you cannot suddenly move assets out if your business is subject to creditor action.
- Succession planning. A holding company may help you transfer wealth to the next generation using an estate freeze, thus transferring growth to the next generation and locking in the original owner’s tax liability. In addition, if you plan to sell your operating company, doing so may be easier if investment assets are in a separate holding company because potential purchasers are likely interested in buying only the operating assets.
When should a holding company be used?
One appropriate time to create a holding company is when your operating company may be growing too large to still be considered a small business. You can stay within the small business definition by removing retained earnings from the operating business and flowing them to the holding company so that at least 90% of the operating company’s assets are used in active business. If your operating business needs cash, the holding company can simply lend the funds back to the operating firm.
If your business has funds available to invest, it is often better to do so within a holding company rather than the operating business to keep the operating company within the small business corporation limits and to optimize creditor protection, tax deferral and income splitting.
Check back periodically – and get professional advice
Having a holding company does make your corporate affairs a bit more complex, so revisiting the structure of your corporations to ensure it all still makes sense in your situation is important. It’s best to do this every couple of years, and consider getting a second opinion as well. Your accountant or another advisor may have experience that will enable them to see things from a different perspective and to come up with a better idea of how to set up or adjust your holding company or trust.
You can apply additional strategies within a holding company, such as purchasing tax-exempt permanent life insurance or holding U.S. investments to shelter Canadian shareholders from U.S. taxes. To take advantage of these complex strategies, it is essential to discuss your situation with a qualified tax law expert.