You should consider both the tax and non-tax benefits
Holding companies can be used to reduce tax as well as provide important non-tax related benefits. While each situation may be different, as your company’s annual revenues and income increase, a holding company is likely something you should consider.
The potential benefits, including tax deferral and savings, income splitting opportunities and asset protection, will usually far outweigh the costs of incorporating.
What is a holding company and where does it fit?
A holding company is a corporation that owns shares in another company. It is typically positioned between the operating company and the individual shareholder, and it owns the operating company’s voting stock and assets, and controls its management and policies.
It doesn’t usually produce goods or services itself.
Defer and save tax
Holding companies can help your shareholders defer and save tax on earnings because dividends from Canadian corporations are allowed to flow tax-free between companies.
Earnings from an operating company can be distributed to individual shareholders as dividends. But if paid to individuals outside of a tax-savings vehicle such as an RRSP, personal income tax is owed on the dividends in the year they’re distributed.
If dividends are paid to a holding company instead, they can be held in the holding company tax-free. This accomplishes three things:
- it allows your shareholders to defer paying income tax until the earnings are withdrawn at a later date
- it lets your shareholders determine when they will withdraw the funds and potentially save tax (perhaps after retirement when in a lower tax bracket)
- it allows the full amount of the dividends to be available to the holding company for reinvestment in other assets
Qualify for capital gains tax exemption
When you sell shares in your company, if they are deemed to be Qualified Small Business Corporation shares and they meet certain tests, they may be eligible for an $800,000 lifetime capital gains tax exemption.
One of the tests is: A company must be a Canadian-controlled private corporation and at least 90% of its assets must be used in an active business in Canada.
Operating company profits that are not re-invested in the business can easily accumulate and become more than 10% of total assets. Separating excess operating company income (and other assets) to a holding company can therefore help the operating entity meet the above test.
It’s important to note that other tests also apply, and seeking professional advice when determining if shares qualify for the exemption is essential.
Split your income to minimize tax
Tax can also be saved by splitting income, and a holding company can enable this – something especially beneficial for a family-owned business. By paying dividends to the holding company, the shareholders can ultimately determine who receives the income.
Family members can subscribe for shares in the holding company, and tax can be minimized by splitting the income amongst individuals in different tax brackets.
Protect your assets from creditors
A final advantage a holding company provides is asset protection. If an operating company goes bankrupt or faces liability issues, creditors and litigators can go after its assets. For a small to medium size business, one claim can put a lifetime of accumulated profits at risk.
If excess earnings, investments and other assets have been separated to a holding company they are beyond the reach of creditors and liability claims originating from the operating entity.
Because of their high value, especially in a market like the Lower Mainland, separating real estate assets to a holding company can provide an additional benefit. While it protects the equity you’ve invested in real estate from creditors and the courts, it also provides some advantages when it comes time to sell your business.
Separating real estate assets reduces the value of the operating company, which can ultimately make your shares more affordable for buyers. As a business owner, you want to sell your shares rather than your business assets, so you can take advantage of tax savings such as the capital gains tax exemption on Qualified Small Business Corporation shares mentioned earlier.
Get help from a business advisor
When it comes to saving tax and protecting your assets, a business advisor can help determine if a holding company is right for your business. As a business owner, you want to take advantage of every option available, and a holding company can help you accomplish this.
This article was written by BlueShore Financial.