A holding company is a company that owns shares in another company. If the holding company owns the majority of shares of another company, it is also referred to as a parent company. It generally does not produce goods or services itself. The sole purpose of a holding company is usually to own shares in another company.
The reasons for establishing holding companies are diverse. They may be created to operate for a short period of time or as part of a long-term plan. Whether it is better to form a holding company to hold your shares rather than you holding them personally requires significant consideration of your individual circumstances and proper advice from qualified professionals. Factors to consider include the nature and revenue of the business, the jurisdiction in which the business owner resides, and the business owner’s long term goals. In this article I have outlined some of the benefits and drawbacks associated with creating holding companies.
Minimize Exposure to Risk
Holding companies may protect a business owner's interests by minimizing exposure to risk and by keeping creditors at a distance all the while reaping the benefits of the operating company's goodwill. Subject to certain rules, you can remove cash from an exposed operating company to a holding company on a tax free basis. Business owners can take risks through the operating company and limit risk to the operating company alone rather than exposing the holding company. This is because the holding company performs no transactions and therefore does not move cash and other assets around. The holding company is exposed to risk only to the extent of its investment in the operating company. If a holding company lends money to the operating company, it can secure the debt and become a secured creditor of the holding company. This gives the holding company priority when it is time for the debt to be repaid.
- Depending on the percentage of outstanding shares held by the holding company in the operating company, the dividends paid to the holding company may be tax free.
- For shareholders with a high marginal tax rate, a portion of tax on dividends from taxable Canadian companies may be deferred until dividends are paid by the holding company to the shareholders.
- You may be able to locate the holding company in a province with a lower corporate tax rate.
Holding Companies may help with succession planning by facilitating the transfer of wealth to the next generation. Shares in an operating company can be transferred to younger family members through a holding company by way of an estate freeze, structured to cap a person's tax liability upon his or her death and transfer any future growth to family members.
Set Up Costs
Holding companies require additional set up costs and these expenses can be ongoing, including the cost of preparing annual financial statements and corporate tax returns. Unless your shares are of significant value, a holding company may not be worthwhile.
No Tax Benefits or Negative Tax Implications
- Any losses realized in a corporation are only available to offset other income earned by the corporation.
- Holding companies are not eligible for the $750,000.00 capital gains deduction.
- In some instances, if certain qualifications are not met, a holding company can introduce an additional level of tax in addition to any personal income tax on distributions from the holding company. This is due to corporate tax on the income earned by the holding company. Double taxation of the underlying income may result.
To avoid the negative tax consequences associated with the payment of funds from a holding company to a shareholder, tax efficient ways of distributing funds to shareholders should be considered. Mechanisms to mitigate or eliminate negative tax consequences include the repayment of shareholder loans and taxable dividends (which may result in a refund of corporate tax to the holding company). More such tax minimizing mechanisms may be available, depending on your circumstances.
With correct advice, holding companies may provide tax savings and help you reach your estate planning goals. Individuals interested in creating a holding company should first seek assistance from a lawyer, accountant and/or other qualified professional. These professionals will provide information and advice customized to assist you with your particular situation.