Holding Company in Canada: Is It Worth Setting One Up?

Adding a holding company to the corporate structure is a popular strategy for large businesses, but smaller businesses and entrepreneurs can also benefit from having a holding company.

Let’s take a look at what a holding company is and the benefits of setting up a holding company in Canada.

What is a Holding Company?

A holding company is a corporation that’s not active, meaning it doesn’t produce goods or services, but can hold shares of other companies and investments. This can include real estate, shares in public companies, interest-earning investments, etc. 

If your holding company owns shares of your operating company, you can shift profits from your operating company to your holding company, which is beneficial for many reasons, including saving you tax.

What Are the Benefits of a Holding Company in Canada?

1. Creditor and asset protection benefits

As a business owner, your company’s daily operations expose many liabilities—whether it be interactions with customers, employees, vendors, or creditors. By keeping some of your assets in your holding company, it reduces legal risks.

If something goes wrong in the economy or with a service provided by your company, creditors can go after assets held by the operating company. But they generally cannot go after the assets held by the holding company. This holds true most of the time.

2. Tax saving benefits

Having a holding company allows you to transfer retained earnings from the operating company to the holding company via tax-free dividends. As the individual shareholder of the holding company, you can withdraw income or dividends as you need.

(Why dividends? Learn the difference between salary vs. dividends)

This provides the flexibility to control how much income you receive through dividends. In a way, this means you can decide how much tax you will pay.

For example, if you are in a very high tax bracket for the tax year 2021, you can have your dividends paid to your holding company to defer your income to the following year, 2022, and reduce your tax bill for 2021.

(Are you paying too much passive income tax? Learn how to decrease taxes on passively generated income

You can also find yourself saving taxes because corporate tax rates are lower than personal tax rates. So instead of withdrawing that money out and being taxed personally, you can keep it in the holding company where it can continue to earn money through investments.

3. Liquidation benefits

Keeping your investments and real estate inside the holding company makes it much easier to qualify for your Lifetime Capital Gains Exemption (LCGE) when you sell shares of your small business.

The LCGE provides small business owners in Canada with tax-free capital gains of up to $913,630 on the profit earned from selling your small business shares. But to qualify for the LCGE, the operating company must meet a set of criteria. 

Two of the criteria are asset tests:

  • Asset test – At the time of the sale, 90% or more of the company’s assets must be used in active business and not passive investments
  • Basic asset test – For the 24 months before the sale, 50% of the company’s assets must be used in active business and not passive investments

Business owners tend to keep money in their operating company and invest in there, which will most likely rule you ineligible to meet these asset tests. 

Instead, you want to transfer excess capital from your operating company to your holding company and invest there. This will help the operating company meet both asset test criteria to qualify for the LCGE.

4. Estate planning and freezing benefits

When estate planning, a holding company helps create a more seamless transfer of wealth from one generation to another. 

Through an estate freeze, a shareholder’s interest in the company is frozen upon their death and new shareholders (typically children) come into ownership. At this point, any earnings going forward will go to the ‘new’ shareholders. 

(Looking for estate planning tips? Here are six that will help both you and your family)

Is Having a Holding Company Right for You?

To recap, a holding company can provide flexibility in the timing of dividends payments to shareholders, protect assets, help with tax savings, and estate planning. 

Despite all the benefits of owning a holding company, there are potential drawbacks. One of which is the incorporating costs of having a lawyer incorporate your holding company. You can do it yourself, but it’s a complex process with a big risk of mistakes. Another drawback is the ongoing costs of administration and annual filing fees of corporate tax returns.

Setting up a holding company can add a lot of complexity to your business structure and may not be suitable for everyone. It’s important to consider your financial situation and goals with a financial advisor before making a decision. 

If you want to make the most of your corporation to get further ahead. Book a call today; we’d love to help.

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