Thinking About a Holding Company? Things to Consider

One question I get asked often is if it makes sense to set up a holding company (Holdco). A Holdco is just that: it holds investments like real estate and shares of other companies. There is usually no active business inside the company and its earnings are from passive types of income.

If you already have just an operating company (Opco), you can transfer your ownership of shares into Holdco without triggering any tax. After this transaction, you would own shares of the Holdco, which would own shares of Opco. Below are some of the reasons you might want to consider setting up a Holdco.

Creditor Proofing Your Funds

If you have an Opco that has accumulated excess cash inside it and are sued for whatever reason, there is a chance these funds could be taken as potential damages. Or if your company has fallen on hard times, the bank could look at any excess assets to recoup their debt in a restructuring. Setting up a Holdco that sits on top of your Opco will allow any excess cash to be dividend up tax-free to your Holdco and remove the risk of these assets being part of a lawsuit or liable in a potential restructuring.

Timing of Income

If you own a smaller percentage of a company that pays dividends but don’t want to take any income out because you are in a high tax bracket or the income could push you into a higher tax bracket, flowing your dividend to your Holdco allows you to control when you receive your income from Opco.

As long as your Holdco and Opco are what is known as “connected corporations” (you own more than 10% of each company), the Opco can pay dividends up to Holdco on a tax free basis. Instead of being taxed personally at your marginal rate when you receive the dividend, it is retained within HoldCo. This results in a larger dollar amount to be invested until taken out personally.

Accessing the Capital Gains Exemption

Having a HoldCo that receives all the excess funds from Opco gives Opco the ability to meet the qualified small business corporation tests to obtain the capital gains exemption. I won’t get into the main rules that allow the capital gains exemption, but having excess redundant assets sitting on the balance sheet could put you offside. Transferring them to Holdco is a way to access the capital gains exemption for your Opco.

Having said that, accessing the capital gains exemption upon a sale of your business is only possible if you hold the shares of Opco personally. Since you would now own shares of Holdco, which in turn holds shares of Opco, there are certain criteria to be met to qualify. This is known as stacked companies (I’ll save the CGE criteria and stacked company rules for another blog). Holdco is not able to sell shares of Opco and obtain the capital gains exemption.

Access to Funds

If Opco ever needs any funds for working capital, potential acquisitions or other growth initiatives, Holdco can loan the money back down to generate interest income, and Opco can shield taxes by paying deductible interest.

You may need a General Security Agreement to be drawn up by a lawyer for this. You should also speak to your bank if you currently have some debt on your balance sheet, as they will want to rank higher on the priority scale than your Holdco.

Makes Business More Salable

Acquirors might only be interested in the operating business and not all the assets that come with it. By cleansing or purifying the operating company of excess funds, it makes a sale more efficient.

Holdco Owns the Real Estate

If your Holdco owns the real estate that your Opco works out of, you can classify the rental income your Holdco receives as active business income under 129(6) of the ITA. This will allow Holdco access to the small business tax rate for that income. This is because the two corporations are associated under the Income Tax Act.

Things to Keep in Mind

Any two companies that are associated (as the Holdco and Opco would be if 100% owned by a shareholder) could have the small business allocation of $500,000 ground down. For every dollar that passive income is over $50K in the combined companies, there is a $5 reduction until it is completely gone at $150K in passive income. Same thing when the total associated corporations’ taxable capital employed reaches a certain amount. Don’t ask me to define “Taxable capital employed in Canada”. If you are really interested in the definition you can go to Section 181.2 of the Income Tax Act. As soon as the taxable capital goes over $10m, every dollar over reduces the $500K small business allocation down by $10. Once it reaches $50m, the small business deduction is wiped out.

Introducing a holding company will add increased legal and accounting costs as financials and tax returns need to be done with the necessary legal filings as well.

If you operate a medical, legal or accounting professional corporation, you need to look up in your province if your professional Opco can be owned by a Holdco. Legal professional corporations in Ontario can be owned by a Holdco but the shareholders of the Holdco must be lawyers. The College of Physicians and Surgeons of Ontario do not let medical professional corporations to be owned by Holdco’s.

 Ultimately it depends on everyone’s situation whether they want to introduce a holding company. Determining whether you need a holding company is beyond this blog post and should be investigated by you and your tax advisor.

DISCLAIMER: The articles posted on TaxCrunch should not be considered specific advice to anyone readying. Please reach out to a professional advisor to seek guidance on any issues mentioned in this post before acting upon anything written here. All posts are time sensitive to what is law at the time written and are subject to changes in legislation.