Holding corporations are used to achieve certain tax and/or legal benefits. They can be introduced into the corporate structure at anytime.
So, what is a holding corporation?
A holding corporation (hereafter “holdco”) is a regular corporation that is placed between the individual shareholder(s) and the operating corporation(s) (“opco”). Simplified, the individual owns shares of the holdco, and the holdco owns shares of the opco.
Benefit #1 – Creditor Protection
A holdco can provide creditor and legal protection. This can also be achieved without a holdco, however the payment of dividends to the individual will result in personal taxes. By paying dividends to a holdco (generally without additional taxes – see benefit #2) the value of opco is reduced. The dividends paid to holdco are then loaned to the opco on a secured basis. Should opco ever be successfully sued then the secured creditor (holdco) is paid first.
Please note: This is a very simplified explanation, and proper execution of this requires the involvement of both a lawyer and an accountant. A lawyer should be consulted regarding the effectiveness of the creditor protection aspects prior to implementation.
Benefit #2 – Tax-free Cash Flow
Another reason to use a holding company is that cash may be able to be paid to the holdco as dividends without triggering addition taxes to the corporate group (assuming they are connected). By doing so, opco avoids large cash holdings and you do not need to pay personal tax rates. This is particularly helpful when wanting to claim the capital gains exemption when the shares of an opco are sold.
Benefit #3 – Small Business Tax Rates for Debt Servicing
When shares of a business are purchased, it is beneficial to purchase the shares in a holding company. A loan taken out in a holding corporation will be paid off using lower taxed income (i.e. more cash) than a loan obtained personally. If you had to take the cash personally to pay off the loan, then a dividend will trigger tax.
Benefit #4 – Tax Planning for Multiple Shareholders
Each owner of the business may have very different personal circumstances. Using a holding company will allow each shareholder to do their tax planning separately. A person who wants to invest the excess cash can invest at the holdco level whereas a person who needs all their cash personally can withdraw it all. This allows all the shareholders to plan their own affairs in the most tax advantageous manner without needing to worry about the other shareholders.
So, is a holdco right for you?
This is not a simple answer – Some factors that would lead you to *want* a holdco are:
- Your business generates significant profits, but you do not need it all personally
- You are operating a high-risk business
- You have two or more individuals working together in the same business with different personal circumstances
- You have built up significant cash or investments in the corporation and you need to remove the cash for estate planning or retirement reasons
This is a great discussion to have with an accountant, as they can help you understand how a holdco will fit in to your own unique situation, explain the benefits and drawbacks, and walk you through the steps needed to set one up.