Using a Holding Company:

Dividends paid between connected Canadian corporations do not usually attract tax.

This is just one beautiful advantage of a holding company. When your assets build up, your business gets riskier, and you need legal methods to ease the tax burden, a holding company could be the answer.

First, your small business needs to be incorporated. A holding company only works if you’re transferring assets from one corporation to another. If you haven’t incorporated yet, that’s the first move to consider.

Once you’ve incorporated and your assets are starting to become a burden (yes, it happens), then you can talk to a lawyer and an accountant about forming a holding company (also referred to has a “holdco.”)

Your operating company (or “opco”) is your actual business, the one you serve people from. The holdco has no dealing with the public (unless it’s investing) and it produces no goods or services. It exists solely for the purpose of holding shares in your operating company and managing your assets.

A holdco acts as a bank. You put money into the holdco for safe keeping and certain tax advantages. When you need the cash, the holdco can lend money back to the opco.

When the holdco is formed, it buys a controlling share of your opco. It becomes the “owner.” You put money into the holdco by paying out dividends to it each year. Inter-corporate dividends are usually tax free if the two companies are “connected” for tax purposes.

Generally holdcos can’t be successfully sued because they have no direct interaction with the public. So if your opco is sued, all of the assets that are under the holdco are protected.

But that’s just the tip of the iceberg. Holding companies have many other functions.

Limit Vulnerability

A holding company is the buffer between your active business and the assets it’s amassing. It’s not a perfect protector, though. The holdco is liable to the extent that it’s invested in your operating company.

But the other investments that the holding company makes, as well as dividends earned over the years, are safe when your opco is in a legal battle.

If people know that you are solvent (you have money spend, not tied up in debts), you become a target for litigation. Some will do whatever they can to get a piece of your accrued wealth.

Beyond legal protection, a holding company can be a stabilizing force when business gets tight.

Your market may slow down, costs increase, or competitors eat up your market share. As you build strategies to overcome any business setback, you may need financial help to keep cash flowing. If you have assets in a holdco, it can loan money to your opco as secured debt.

“Secured” debt means that the lender has priority when creditors come looking for their money. Your holdco would have first claim on assets if your business couldn’t recover (and files for bankruptcy).

Setting up a holding company cannot be a response to litigation though. You have to already have your assets in the holdco when legal action is taken against you. Start thinking about it now, before you run into any obstacles, legal or financial.

Ensure Your Family’s Future

Holdcos can be a component of an estate plan. For example, you can “freeze” your estate by rolling your assets into a holding company, taking back fixed value shares for the current market value of your assets then transfer the future value to the chosen beneficiaries of your estate by issuing them common shares of the holdco.

Estate planning using holding companies (and sometimes trusts) require an in-depth knowledge of tax and law so this will be the topic of other articles.

Taxes Take a Smaller Chunk

The first tax break you get is on the dividends paid from the opco to the holdco. Most of the time, dividends paid between connected corporations are tax free. If you are paying yourself in dividends from the opco, you’ll be taxed. This is a way to keep the assets in your control and defer taxes.

Income splitting is another way to keep the tax burden light, as long as your family members’ personal tax rates are lower than yours. You can issue special shares to your family from the holdco. When they are paid, they are taxed at their personal rates.

These strategies are only the beginning and require a lot of planning. Make sure to consult a lawyer and an accountant when you hope to find legal ways to ease the tax burden.

But Beware...

There are a few things you need to know before deciding to set up a holdco:

Conclusion

Opening a holding company is an excellent idea when your business is walking into risky areas or you’ve been met with such success that your assets need additional protection.

But there are many consideration and there is a lot of planning involved, just like setting up any corporation. You absolutely need to consult a lawyer. Opening a holdco is a legal process. But you also need the professional attention of an accountant.

A holdco is another business structure to plan with taxes and payment strategies that need careful attention. We’ve helped many business open holding companies and keep their taxes down.

If you’re thinking of opening a holding company, call us. We’ll walk you through the process and we have some very good lawyers that we can work with you keep you protected and stable.