Building Wealth and Security: The Strategic Advantages of a Holding Company
When it comes to structuring one’s business for optimal financial and operational efficiency, advisers will strongly recommend integrating a holding company into your single operating company structure. This approach offers a myriad of benefits, including enhanced asset protection and tax advantages. By establishing a holding company, business owners can create a robust framework that not only segregates valuable assets from the operational risks associated with day-to-day business activities but also facilitates strategic financial planning and tax savings.
1) Asset Protection – Creditor Proofing
The general premise here is that an active operating company is inherently precarious to liability from its creditors, suppliers, customers and employees; an operating company can be sued by any of these parties at any time. It would not be wise to retain your profits within this entity that is inherently precarious to lawsuit or enforcement action thereby jeopardizing both the operating company’s profits as well as valuable assets.
The solution is to layer-in a passive holding company which sits above the operating company as its sole shareholder. Once the holding company is established and incorporated into the structure, it is recommended to draw up any excess funds (all cash over and above month-over-month working capital that is required for the operations of the business) to holding company via intercorporate dividends provided this amount is within the corporation’s safe income balance. If the two corporations are Canadian connected corporations, the intercorporate dividend attracts a rate of 0% tax on the
transfer upwards.
By introducing the holding company to the single operating company structure, and by subsequently drawing up the excess cash via a dividend to the holdco, you have creditor-proofed your operating company by ensuring that there is no pocket of cash that a claimant can seize in a suit. You have swept all excess cash upwards and into a safe entity. The very feature of a holding company is that it does not engage in any active operations and therefore it has no exposure from creditors, suppliers, customers
or employees as there are none. If structured properly, the holding company is a full-proof entity in which your excess cash can accumulate and grow.
The above maneuver can also be completed with tangible assets as well such as vehicles or equipment, oftentimes moved over and held by a sisterco which will then lease or licence the asset back to the opco. The benefit is the same in which a non-active entity with no liability exposure is the title owner of the assets under use by the active operating company thereby protecting it from claimants.
2) Income Deferral
In Canada, individual marginal tax rates are notably high. Marginal tax rates means that the rate of tax increases the more income you earn. This contrasts with tax rates for corporations which are a flat tax (as opposed to marginal) and are comparatively low; in Ontario the combined federal-provincial corporate tax for a Canadian controlled private corporation, (CCPC) is 12.2% flat on net income up to $500,000.
Drawing from the concepts above, it would not be wise to accumulate your excess cash within an operating company due to liability, and so there is a natural desire to push that cash up to the shareholder level. If you are a personal shareholder of a corporation (in other words, there is no holding company), then when the corporation declares a dividend being a distribution of profit, this will invariably push income to the individual shareholders pocket. This would result in a high marginal tax rate, which is an outcome we wish to avoid. However if the shareholder was a holding company as opposed to an individual, pushing that income up would garner absolutely no tax due to the intercorporate dividend rules.
If the tax rate inside the operating company is only 12.2%, then the opco is paying only 12 cents on every dollar in tax. If you were to distribute profit via a taxable dividend to the individual shareholder, this would trigger a high rate of secondary tax of up to 54% in this year. However using a holding company, you are able to move the remaining 82 cents up to a holding company without paying any secondary level of shareholder tax in this year, thereby allowing you to grow your wealth at a much more rapid pace and allowing you to defer a high rate of secondary level tax to a future year. Thus, the
benefit of a holding company is tax deferral.
It is important to note that you may invest the excess cash within the holding company by opening a portfolio with any investment bank and purchase stocks or bonds; you can also invest in real estate or other capital property within the holding company without shareholder extraction. You will only pay a second level of shareholder tax when and if any funds are extracted from the holding company to the personal shareholder, thereby deferring this large rate of tax to a much later date.
By layering-in a holding company and declaring an intercorporate dividend to the company as opposed to the individual shareholder, you are deferring an enormous amount of tax to a future year, when and if you decide to declare that dividend up one further level to the individual shareholder.
Section 85 Rollover
Regardless of your reasons for layering-in a holding company to your structure, the only way to achieve this outcome is by utilizing s.85 of the Income Tax Act to rollover the shares you own of your opco to the newly formed holding company.
The general rule in tax law is that any transfer of capital property triggers capital gains tax, and any transfer of capital property must be made at fair market value. Shares of a private operating company are capital property and so if you were to transfer the ownership from yourself to a newly formed holding company, the law would deem this to occur at FMV and tax you on the differential between your adjusted cost base and the fair market value.
However, s85 of the Income Tax Act recognizes that a taxpayer may wish to transfer their shares to a holding company of which they wholly own. If this is the case, you are permitted to ‘rollover’ your personal ownership in your operating company to your holding company on a tax free basis, provided the holding company issue you back a certain number of shares within its capital as payment for the shares rolled in. Additionally, a form named T2057 must be filed with the CRA to elect under this provision. At Kalfa Law we take care of both the corporate and tax components of this tax-free rollover including filing the T2057 form with the CRA.
If you wish to discuss whether a holding company is right for you or learn more on how to implement this dual structure, contact us for more information.
-Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and private M&A law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law.
© Kalfa Law 2024
The above provides information of a general nature only. This does not constitute legal or accounting
advice. All transactions or circumstances vary, and specified legal advice is required to meet your
particular needs. If you have a legal question you should consult with a lawyer.
