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What is a holding company and when to use it - Strata-G Blog

A holding company is a little like a silent partner in a business. It operates behind the scenes without actively contributing any goods or services, but it holds shares or investments in the company. And while bookkeeping may become somewhat more complicated when a holding company is present, there are several upsides to going the holding route.

So, when would you make use of a holding company and why would it be necessary to do so if you already have an established operating company? Here are a few fast facts about holding companies and why you may (or may not) want to consider using one

Keeping Good Company

People generally don’t realize that the word “company” usually describes an operating company in everyday terms. An operating company provides a product, goods, or services. Making the distinction between an operating company and a holding company can be beneficial because being a shareholder in both allows you to shift profits from your operating company to your holding company.

 

Company assets can also be kept in the name of your holding company. This can help protect your assets and protect you against creditors. If you have excess earnings in your operating company each year, you may want to move the excess funds to a holding company. By transferring these assets, the earnings may be protected from creditors of your operating company. Likewise, if your operating company needs working capital, your holding company can securely lend the necessary capital to your operating company.

 

If you’re experiencing any type of financial crisis, creditors generally can’t go after the assets held by the holding company, only the ones held by the operating company. That does come with a disclaimer, though. These rules only apply if everything is transparent and above board. Anything that doesn’t fall into normal business practice – like fraud or negligence – is not protected, even in a holding company.

Investment

Keeping earnings and assets in a holding company also has tax advantages. Earnings can be transferred as tax free dividends, which can then be re-invested. Shareholders in the holding company can withdraw their income or dividends when necessary and family members who are also shareholders, but have less income, can be paid in dividends, within the bounds of Tax on Split Income (“TOSI”). Although a discussion of TOSI is beyond the scope of this article, TOSI relates to the rules for determining whether an individual will be taxed at the highest marginal tax rate on income derived from a business. Starting with the 2018 tax year, these updated rules apply for adults aged 18 or older.1 Individuals may be excluded from TOSI if the income they receive in the year comes from excluded shares, provided they reached the age of 25 before the end of the year in which the income was received.

Remember, corporate tax rates are significantly lower than personal tax rates. So, provided you don’t need the personal income, it makes absolute sense to keep earnings in the holding company where they can be bolstered through sound investments2 including:
  • Individual Pension Plans
  • Shared-Ownership Critical Illness Insurance
  • Tax-Exempt, Corporate-Owned Life Insurance
  • Leveraged Life Insurance & Immediate Financing Arrangements (IFA)

We recommend that you speak with a financial advisor to explore whether these investment strategies are right for your business.

Tax Matters

An investment holding company can be used to implement an estate freeze, the purpose of which is to “freeze” a company’s share value for the original shareholders and pass on the future growth of the corporation to the next generation, or other shareholders as part of a succession plan.

 

In addition, Holding Companies will assist in crystalizing the lifetime capital gains exemption (in 2021, if you disposed of qualified small business corporation shares (QSBCS), you may be eligible for the $892,218 LCGE), through the transfer of qualifying small business corporation shares in an estate freeze. This may be advantageous to you if your shares currently qualify for the LCGE but may lose their eligibility in the future.

Please note:

Holding Companies that are used only to hold an investment portfolio
do not qualify for the capital gains exemption.

Final Thoughts

There are a few drawbacks to owning a holding company, although these are mostly operational and cost-related, you should still familiarize yourself with them before taking the leap and purchasing a holding company.

First, it can be costly. Startup costs like incorporation fees and the ongoing cost of tax compliance, financial statements and accounting red tape can add to your bill. Legal and tax documents must also be kept up to date, which can incur additional cost. Plus, it can be complex to keep track of assets and income streaming in from various sources, so you’ll need a professional to provide support. At the end of the day, there are numerous benefits to having a holding company, but the complex issues around establishing it and managing it are best navigated by a professional. At Strata-G, we offer fully comprehensive virtual accounting services from corporate tax to bookkeeping, tax consulting to startup accounting, accounting software management and more. Send us a message online and we’ll help you figure out the best strategy with our next level accounting services.

We’ll help you figure out the best strategy with our next level accounting services.

Nicholas Coburn

Nicolas Coburn, CPA, CA, has 15+ years of experience spread across Government Audit, Industry Financial & Tax Reporting, and Big 4 Canadian Accounting Firms.