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Benefits of having a holding company in Canada. Is it worth it?

Holding companies are a common term that many people associate with big businesses and offshore accounts in Canada. In major Canadian centers like Vancouver, holding companies are quite common. 

But holding companies are not just reserved for large businesses in Canada. However, before a business dives into owning and using holding companies for their local or small business, they need to ask themselves – is it worth it? 

A good place to start, to better understand holding companies and whether or not businesses should use them, is to define what a holding company is. 

A holding company is a company that isn’t active. This means that the company doesn’t produce any goods or services, but it can hold shares of other companies and investments. This can include your own operating company, shares in public companies, real estate, market securities and so on.

A company that produces goods or services is referred to as an operating company. However, operating companies are what are most understood to be companies. 

If you are a shareholder of both companies, then you have the opportunity to shift your profits from your operating company to your holding company.

You may also choose to keep all of your company assets in your holding company, which could include any land, buildings, vehicles and so on. Then you would simply have your operating company pay your holding company monthly rent for the land or building.

What are the benefits of a holding company?

1. A holding company can help with asset protection and creditor protection.

What this means, is that if something goes wrong in the economy or with a service that your company has provided, creditors generally cannot go after the assets held by the holding company, they can only access assets held by the operating company. 

If the operating company doesn’t have any assets, then you will be in a much better place. 

It is important to note that you need to ensure that your holding company is set up well in advance of any potential problems. This is because you may not be allowed to transfer your assets from your operating company to your holding company while you are being sued or as your assets are being seized.

One exception to this, is if the corporate veil is pierced. This means that something has been done outside of normal business activities, like fraud, negligence and so on. At that point, your assets would not be protected, even in a holding company.

2. Holding companies help with tax planning.

Another reason to transfer retained earnings from the operating company to the holding company is for tax planning. You may be able to transfer the retained earnings as tax free dividends, which can then be re-invested.

It is always important to discuss this with a professional though, as anti-avoidance rules may treat this transfer as a capital gain. Anti-avoidance rules are those set up by the government to prevent reducing, deferring or avoiding paying tax.

3. Holding companies don’t only help tax planning – but also help with tax saving. 

Tax savings are another reason for you to have a holding company. When you have transferred the earnings from your operating company to your holding company, it allows the individual shareholders in the holding company to withdraw their income, or dividends when needed. If your family members are also shareholders and their personal income is less, it may make more sense for them to be paid the dividends. 

This is also known as income splitting. There are some restrictions when it comes to income splitting. These include that the family members not only need to be part of the company but that they need to be the age of majority as well.

With corporate tax rates lower than personal tax rates, it is beneficial to keep the money in the holding company where it can continue to earn money through investments if you do not need it as personal income. A summary of provincial tax information can be seen in the image below. 

Holding Companies Canada

4. Lifetime capital gain exemptions.

Another benefit of a holding company is the lifetime capital gains exemption or LCGE, which for 2021 is $892,218. This means that if you decide to sell your company this year (2021) for a $1,000,000 profit, or capital gains, you can subtract the LCGE from your profit to determine what you pay tax on. 

In other words, you would only be paying tax on $107,782  ($1,000,000- $892,218=$107,782) rather than paying taxes on $500,000 ($1,000,000-$500,000). In Canada, 50% of the value of any capital gains are taxable, so this is a significant amount of difference (paying tax on $500,000 vs $107,782).

As with everything, there are certain criteria that the holding company must meet. This includes that the owner needs to have owned the shares for at least 2 years before selling, that 50% of the companies assets have not simply been passive investments for that same period of time and finally that at the time of sale, that 90% or more of the company assets are not passive at the time of sale.

5. Ease of estate planning and freezing assets.

Another benefit of a holding company is when it comes to estate planning or freezing your estate. What this means is that the shareholder’s interest in the company is frozen and new shareholders (typically children) come into ownership. At this point any earnings going forward will go to the ‘new’ shareholders.

How this works, is that the current shares become preferred shares, and these shares become frozen at a value equal to the company’s current value. The new shareholders will then be issued common shares for a minimal cost, and as noted above, the future profits will go to them.

Whether or not the preferred shareholder decides to recognize the capital gains at that time or not would be something to discuss with their accounting professional, as the rules can always change. 

At this time, it only makes sense to recognize your capital gains if your company would sell for more than the LCGE mentioned above. 

What are the drawbacks of owning a holding company?

Despite these great benefits of owning a holding company, it’s important to understand the potential drawbacks before purchasing an owning a holding company. 

What are some possible drawbacks of a holding company? If you are looking at setting up a holding company so that you can take advantage of the benefits noted above, the drawbacks are simply operational and additional costs. Canadian business owners in business hubs like Vancouver need to take note of these drawbacks before purchasing a holding company.

1. Incorporation costs

These are the costs that you would incur to have a holding company incorporated by a professional. You could minimize these costs by doing it yourself, but only if you know what you are doing. Otherwise, you run the risk of making mistakes. Its always better to consult a professional.

2. Ongoing costs

Ongoing costs include your fees for annual filings which are linked here, financial statements and corporate tax returns. As well, there will be increased administration costs to ensure that the corporations legal documents and taxes are kept up to date.

3. Higher taxes

It is always important to remember to consult a professional so that your investments or other earnings don’t have you paying more tax, by causing you to be taxed both on your investment income as well as your dividends.

4. Complications

If your holding company has assets and income coming in from various sources, this may get complex for you to keep track of. This could cause you to not know where all of your assets are held, or you may need to hire someone to assist you with this.

Some of the larger disadvantages regarding holding companies come into play when the holding company is more widely held or are conglomerates and not for the benefit of you or your own operating company. 

Some of these disadvantages include reduced transparency, challenges to selling shares, putting other investors at risk and management challenges.  As these can be quite complex topics to explain and to understand, it is best for you to contact your professional.

Always remember to plan ahead and speak with a professional as this can save you at tax time or hurt your bottom line.

Need help from an expert?

If you need clarification on holding companies vs operating companies, their benefits and which make sense for your business, let one of our experts at Valley Business Centre help. For over 30 years, our team has been providing comprehensive bookkeeping, payroll and tax services to our clients in Whistler, Squamish, the Sea to Sky Corridor and metro Vancouver BC areas. We’ll give you the peace of mind you need to make confident financial decisions.

Disclaimer

This article is written for informational purposes only. It is current at the date of posting and changes to laws and regulation may result in the information becoming outdated. It is not intended to provide legal, tax, or financial advice. It is recommended that readers get advice from a tax professional before making any final decisions.

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