Today, we shed light on a crucial aspect of your business that is often overlooked. We explain what a holding company is, delve into the consequences of not having one and shed light on the potential pitfalls that can hinder growth, asset protection and overall business success.
What is an investment holding company?
It’s a term used to describe a corporation that doesn’t have any active business operations itself. A holding company can own shares of a private corporation with active business operations. It can also hold passive assets, such as publicly traded securities, bonds, real estate and so on.
What are the benefits of using a holding company?
Deferring personal tax
A common corporate structure involves a holding company owning shares of an operating company. Integrating a holding company into an existing corporate structure may be advantageous if you want to move excess funds out of your operating company but don’t necessarily want to pay personal tax on the funds. Let’s say, for example, you wanted to extract funds out of your operating company to invest. If you were to pay the excess earnings from your operating company to yourself, personally, you’d have to pay personal tax first, leaving less to reinvest. If instead you had a holding company, it may be possible to move excess earnings from your operating company to your holding company as an inter-corporate tax-free dividend. As such, the use of a holding company can defer personal tax until later, leaving more funds for reinvestment.
Creditor protection
If you have excess earnings in your operating company each year, you may want to move the excess funds to a holding company to protect those earnings from creditors of your operating company. If your operating company needs working capital, the holding company can lend that money back to your operating company on a secured basis to maintain the potential protection from creditors. Similarly, in the case of rental operations, holding rental properties within a corporation may limit your personal liability and provide some creditor protection.
Purifying your corporation
If you sell shares of a qualifying small business corporation (QSBC), you may be able to save a significant amount of tax by claiming the lifetime capital gains exemption (LCGE). For the shares to qualify, there are two conditions that must be met. First, at the time of disposition of your shares, the corporation must be a small business corporation (SBC). An SBC is a Canadian-controlled private corporation (CCPC) where all or most (90% or more) of the fair market value (FMV) of the assets are used in an active business carried on primarily in Canada. Second, throughout the 24 months immediately before the shares are disposed of, the corporation must be a CCPC and more than 50% of the FMV of the assets of the corporation must be used in an active business carried on primarily in Canada. As such, if you have an operating company where more than 10% of the FMV of the assets are not used in active business (for example, your corporation holds a substantial amount of portfolio investments) at the time of disposition or where 50% or less of the FMV of the assets are used in an active business in the 24 months immediately before the disposition, then your shares may not qualify as QSBC shares and you will not be able to claim the LCGE if you sell the shares. To keep your operating company onside with the QSBC requirements, you may want to remove excess funds (not needed for active operations) on a regular basis, or “purify” your corporation, prior to selling the company’s shares to ensure that you can claim the LCGE. You can generally remove the excess funds in your operating company by transferring them to an investment holding company on a tax-deferred basis.
Controlling the amount of income
By investing in a holding company, you have the flexibility in determining when and how much to pay yourself personally. This flexibility may be useful, for example, if you wish to manage your personal marginal tax rate and minimize income that would be taxed at the highest marginal tax rate. In addition, some federal non-refundable tax credits and benefits, such as the age amount (a non-refundable tax credit) and Old Age Security (OAS) benefits are reduced or eliminated when your net income exceeds certain thresholds. By retaining income in an investment holding company, you may be able to manage your personal income to keep it below these thresholds. An investment holding company may also provide flexibility in the situation where you own an operating company along with other shareholders and the operating company pays out income each year. If you wanted to receive your share of the income but did not want to receive it personally yet, having a holding company own shares of the operating company could provide you with this flexibility.
Minimizing probate taxes
If you own shares of an investment holding company, you may be able to reduce the probate taxes on death by using what’s called a “multiple Wills strategy.” This is because under provincial corporate statutes, it may be possible to transfer share ownership on death without probate. The multiple Wills strategy involves having a “primary” Will that deals with assets that require probate to transfer ownership, such as a bank account or an investment portfolio, and a “secondary” Will to transfer assets that typically do not require probate, such as artwork or private company shares. By separating assets in this way, you may avoid paying probate on the assets that do not otherwise require it.
By establishing a holding company, founders can unlock a powerful tool that not only safeguards their assets but also maximizes their business potential, ultimately leading to long-term success and financial stability.
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