A question that I’m often asked by business owners is “Do I Need a Holding Company or is my Operating Company enough?” There are a number of potential opportunities that a Holdco, which owns shares in your OpCo, that can offer business owners a huge advantage over just having an Opco. We’ll take you through a few scenarios where a HoldCo can represent tremendous opportunities to the business owner.*
What’s the Difference Between an Operating Company and Holding Company?
A Holding Company and Operating Companies are both registered incorporated entities. The main difference is that a Holdco doesn’t have active business activities (i.e. revenue for sales, expenses, payroll, etc.). It’s a company used mostly for tax-purposes and creditor protection.
So why might you need a Holding Company? Here are a number of reasons:
If you’re looking for some additional creditor protection, inserting a Holdco into your business structure can help to add an extra layer of security and peace of mind for your business. If you transfer passive assets out of your Opco to your Holdco (i.e. cash), if something were ever to happen to your business (Opco), these assets would be more safely protected from creditors, since they are now sitting in your Holdco.
Qualified Small Business Shares
It’s every small business owner’s hope to one day utilize their lifetime capital gains exemption for the sale of their shares within their business. In order to utilize a business owner’s capital gains exemption, the shares of the business they are selling must “qualify”. Among many of the criteria that the business must meet, the business must not have too much passive income within its Operating company in order to qualify. Holding companies allow you to transfer excess cash out of Operating company in the form of an inter-company dividend (usually tax-free), to ensure that your shares of your operating company remain qualified. **
Holding Permanent Life Insurance Policies
When you’re selling a business, the purchaser likely is not interested in buying surplus cash or cash-like alternatives. Items like permanent life insurance policies (which can have significant cash values) should be kept within the Holdco. When it comes to simplifying the sale of a business, items like permanent life insurance will add a layer of complexity to the sale. Someone looking to purchase your business is not interested in owning your cash or cash alternatives. The life insurance owner would likely want to hold onto this policy and keeping it within a Holdco, thus making the transfer of policy ownership more simplified.
Holding Investments in your Holdco
Dividends can move from Opco to Holdco on a tax-deferred basis. When we move cash out to a holding company, we can then use this money to create a place to invest, whether it be through real estate or other investments. It’s important to note that any growth in this investment portfolio held within a Holdco is subject to the highest corporate tax rate. Also, with the recent Federal government changes affecting Corporately Controlled Private Corporations (CCPCs) this feature is not as attractive to business owners.
Shareholder Dividend Payments
Another significant advantage to a Holdco is when dealing with multi-shareholders within a corporation and when it comes to declaring a capital dividend.
If a dividend is declared by the corporation, the dividend is distributed proportionately to shareholders. Without a Holdco by each of the shareholders, they would have to take the dividend as income personally, whether they want to or not. Depending upon the needs of the shareholder, this can cause friction between shareholders. If one shareholder wants a dividend payment (because they need the money) and the others do not want a dividend payment (because they don’t need the money), it can cause reluctance for some shareholders to declare a dividend.
This is where a Holdco can make all parties happy. Upon the corporation declaring a dividend, each individual would have their own Holdco. Each individual’s Holdco would own their percentage of the Operating company. The dividend flows first to the individuals Holdco, since most dividend payments between Opco and Holdco are tax-free. This allows for the dividend to flow to the Holdco tax-free, at which point the individual Holdco owners can decide what to do, whether they leave it in the Holdco or take it into personal income. They can then keep the money in the Holding company and use it for investment purposes or they can withdraw it to themselves personally at a future date.
Disadvantages of a Holdco
Setting up a Holdco is not for every business owner. It would entail filing a separate tax return for the Holdco and the OpCo which can become expensive relative to the size of your business. As a shareholder of a CCPC, a Holdco can add an extra layer of creditor protection and allow a business owner to sell their business in a more simplified and streamlined manner.
Regardless of what you decide, it’s highly recommended that you consult with an Accountant or Tax Professional to fully understand the consequences of your decision.
* Relating to a Holdco used by a Canadian Controlled Private Corporation (CCPC)
**Note: the use of a Holdco for extensive investment purposes has been recently changed under the Federal government Liberals. For passive income held in a Holdco that accumulates greater than $50,000/year will be subject to significantly larger taxes levied against a Canadian Controlled Private Corporation (CCPC) and will affect it’s small business tax rate in the 2017 Federal Budget
Chris Coulter is the Founder and President of The Finish Line Group. Chris’ purpose in life is to convey the lessons learned from his past experiences so that others will thrive in their lives and be able to minimize the impact of their setbacks.
In business, Chris works with business owners to protect their wealth, reduce corporate and personal taxes, create viable succession strategies and deploy tactics for key employee retention. Chris uses his experience running a successful business for 20 years, only to lose it all after the financial crisis of 2008 to educate business owners on how to protect their assets and their employees.
On a personal level, Chris advocates for youth mental health awareness. Chris lost his daughter Maddie to suicide in April 2015. He shares his family’s experiences and coaches parents on the signs of youth mental illness, coping strategies for teenagers and parents. He believes that by sharing his experiences with Maddie, other parents can avoid a similar fate.
Chris is an avid writer and has published articles in The Huffington Post .