Do I Need a Holding Company?
This is a question faced by many owners of a corporation which is carrying on an active business. First off, let’s address the basic concepts. A holding company is a legal corporation which owns the shares of the business corporation which carries on an active business. In other words, instead of you directly owning the shares of your active business corporation in your name, you would own the shares of the holding corporation and the holding corporation would own the shares of your active business corporation.
The Advantages of a Holding Company
- Tax-Free Distribution of Profits – Any excess cash your active business makes can be flowed through tax-free to your holding company and can be held in the company until you would like to take the money out and into your personal hands.
- Income splitting – This is accomplished by way of members of your family owning shares in the holding company. They can then be issued dividends from the company which is then taxed in their hands at their personal tax rate.
- Creditor Protection – As discussed above, the profits and earnings of the active business corporation can be flowed tax-free to the holding company. Once the earnings or profits are in the company, they are protected from any creditor actions against the active business corporation.
Additionally, if the active business corporation needs money, then the accumulated profits can be lent back from the company to the active business corporation as a loan.
- Re-investment of Profits – Accumulated profits in the holding company can then be used to purchase assets such as real estate. As mentioned above in the advantage of creditor protection, these assets owned by the company are protected from any creditor action against the active business corporation. A common structure is for the holding company to own the real estate property which the active business corporation operates in and then the active business pays rent to the holding company for use of the real estate. This structure effectively protects the real estate asset from creditors.
The Drawbacks to this Structure
- Costs and Administration – As the holding company is a separate legal entity as it is a corporation, it must adhere to the requirements of a corporation. This would involve items such as completing an annual year-end and tax return, filing an annual return, and any legal costs.
- Lifetime Capital Gains Exemption – This is the tax exemption which allows an individual to sell shares in a Canadian Qualified Small Business Corporation and receive $750,000 tax-free in the sale. The difficult part is that this exemption is only allowed to be claimed by individuals or real people, not by corporations such as holding companies.