A holding company is like any other company that has been incorporated. However, unlike an operating company, which is used for running active businesses like a hardware store or a trucking company, the holding company is primarily used for holding investments. The investments held are often in the form of shares of public companies, interest bearing investments such as cash or GICs or bonds, real estate (including residential or commercial rental properties or raw land), or shares in a private operating company, like the trucking company mentioned above.
One of the reasons for having a holding company is to protect assets from liability. If the operating company is being sued, the assets of the operating company are at risk. Excess cash or investments not needed by the operating company can be transferred to the holding company by paying tax-free inter corporate dividends to the holding company. The removal of assets from direct liability then provides the owner with a layer of protection.
Holding companies are sometimes set up on the sale of a business to receive the proceeds of the sale. This allows for the deferral of personal taxes and acts as a vehicle to invest the proceeds of the sale. There are instances where a deferral advantage exists so that a corporation may have a lower tax rate on investments than individuals, so keeping investments inside a holding company can create tax efficiencies. However the biggest advantage is that the owner doesn’t have to personally recognize a large tax bill in the year of sale. Other tax reasons for having a holding company is the ability to access the Lifetime Capital Gains Exemption on the sale of Canadian Controlled Private Corporations that meet certain criteria. We will look at this in greater detail in an upcoming blog.
One common tax advantaged strategy is the use of an estate freeze and income splitting. An estate freeze is a common strategy in estate planning. It locks in the individual’s tax liability before death and transfers any future growth to younger family members. The ability to split income amongst family members, subject to various income attribution and the new Tax on Splitable Income rules, can also be facilitated through the holding company and trust arrangement. Further, you can control when the dividends get paid out, thus creating an opportunity for tax deferral.
Tom owns a manufacturing company. When he retires he wants to transfer his company to his son, Jerry.
Tom has grown his business from the ground up. It is now worth $3 million according to a recent business valuation report he has received. Tom would like to bring Jerry into ownership of the business, but he’d also like to retain control. Jerry would love to take over the company, but still has a lot to learn.
Tom can carry out an estate freeze with the help of his holding company. An asset freeze of Tom’s shares in the company allows him to make his son a shareholder and shift all the future growth to him. It also allows Tom to remain in control of the business. Control can be shifted over time as required.
By completing the asset freeze, it also stops further capital growth in Tom’s hands and fixes the amount of tax that will occur on the deemed disposition of the shares at death. A strategy that now can be employed is the use of an insurance policy to provide liquidity to pay the tax with pennies on the dollar.
However, there are also potential disadvantages. This new corporation will have some costs to consider for its set up. Setting up financial statements, another corporate tax return and maintaining another corporate register all increases your current costs. As well, any losses incurred in that holding company can only be used to offset inside that corporation. Further, because the holding company introduces another level of tax, in addition to any personal income tax on distributions from the holding company, double taxation may result. While integration of income from corporate to the individual is close, it’s not perfect. although it is generally possible to transfer assets to a corporation on a tax deferred, roll over basis, the wind up or distribution of corporate assets to the shareholder is complicated and may entail both corporate and personal tax costs. Finally, not all incorporated businesses need to have another company to hold their assets. Many successful small businesses are ran every day without issue because the potential upsides don’t outweigh the costs.
This is just one example of how your business can benefit from setting up a holding company, it’s important to have a full discussion with a qualified accountant and/or legal professional before any implementation. At CWB Wealth Management, we provide integrated wealth solutions for our clients. Our client teams have strong relationships with accountants and lawyers that can help assess these strategies for you. Please fill out the form below and we will be in touch shortly.
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