Setting up a corporation for your business offers some of the most lucrative financial planning benefits and opportunities.
When setting up your corporate structure, you should consider three components: an operating company, a holding company, and a family trust.
First Step: Should You Incorporate?
If you’re not incorporated, doing so will open up many options for innovative financial planning that are otherwise not available if you were a sole proprietor, someone who is self-employed and not incorporated.
Incorporating your business will often pay off if you plan to grow your business, as most business owners do.
Generally, we recommend incorporating, but each business is unique, and the decision to incorporate is based on specific factors and long-term goals. It’s always important to consult with professionals when deciding to incorporate.
Let’s start with some primary benefits of incorporating:
Limited liability: When you incorporate your business, it becomes a separate legal entity from its owners (shareholders). A shareholder’s personal assets are protected from the business’s debts, liabilities, or legal claims.
Credibility: Operating as a registered corporation shows clients and partners that your business is established and credible.
Access to capital: As a corporation, you can issue shares to secure additional capital from investors, giving you the opportunity to grow and expand the company.
Perpetual existence – Unlike sole proprietorships or partnerships that may dissolve with changes in ownership, a corporation can continue its operations even if there are changes in shareholders. This allows you to sell the company or pass it on to the next generation.
Brand protection – Incorporating your business can help protect your brand and intellectual property rights. It establishes and maintains your unique identity in the market.
Succession planning – A corporation simplifies transferring ownership to family members, key employees, or outside buyers by selling or transferring shares.
Tax advantages – Corporations benefit from tax deductions, lower tax rates on business income, credits, and incentives for development, investments, or hiring employees. In British Columbia, corporate income is taxed at 11% on the first 500,000, whereas personal income is taxed closer to 54% at the highest marginal rate.
Second Step: Setting Up Your Corporation Structure
Setting Up an Operating Company
When setting up your corporate structure, you’ll want to start with your operating company.
An operating company is your core entity engaged in business operations, hiring employees, day-to-day activities, and generating revenue.
The operating company can exist as a standalone entity or as part of a corporate structure that includes subsidiary companies or divisions. In a corporate structure, an operating company is often owned or controlled by a parent company, such as a holding company or a trust.
Setting Up a Holding Company
Possibly most important, you’ll want to set up a holding company. A holding company, also known as a parent company, primarily exists to own and control other companies or assets as it does not engage in active business operations itself.
The holding company is where you will do all of your long-term planning and investing for your financial future. You can move the earnings from your operating company to the holding company completely tax-free.
Here are some key points to understand about holding companies.
A holding company typically owns a significant portion of the shares or equity in subsidiary companies directly or through a trust. In addition to owning shares in subsidiary companies, holding companies can hold other assets such as real estate, investment accounts, insurance policies, intellectual property, patents and much more. Most things an individual can own, so can a holding company. These assets provide additional sources of income or value for the holding company as they grow.
(Your holding company offers many investment options and strategies. We share how you can invest inside your corporation here)
The holding company structure separates assets and liabilities. For example, if your company goes bankrupt, creditors can go after the operating company’s assets, but anything that the holding company owns or personally will be protected from risk.
Holding companies are incredibly valuable in optimizing tax strategies for capital gains, dividends, or other income streams. Proper tax planning using the holding company can result in significant tax savings.
Finally, if you ever sell the operating company, you can maintain your assets inside the holding company and avoid paying a much higher personal tax rate by pulling all of the company’s retained earnings out of the corporation. Remember, the earnings in your operating company are taxed at a much lower rate than your personal income, so it is incredibly important to keep any money you don’t need inside your corporation to avoid the higher personal tax rate.
(Are you using your corporation to save taxes? Here are five strategies to invest and save tax using your corporation)
Setting Up a Family Trust
A family trust is the third consideration when setting up a corporate structure for success. Family trusts can have many benefits, including asset protection, flexibility and control over the distribution of assets, estate planning, and more.
(Curious to learn more about how a family trust can add value to your corporate structure? Here’s everything you need to know)
To fully take advantage of a family trust in your corporate structure, you want your trust to own your operating company and your holding company to be a beneficiary of your trust. This allows you to flow corporate dollars to your trust and then to your holding company tax-free.
The key tax and financial planning consideration of including a family trust in your corporate setup is the Lifetime Capital Gains Exemption (LCGE). The LCGE provides a tax benefit by allowing Canadian individuals to exclude taxation of a certain amount of capital gains from selling qualified small business corporation shares. In 2024, the LCGE limit per individual on the disposal of qualified small business corporation shares is $1,016,836. This amount is adjusted each year to account for inflation.
Here’s how having a family trust can help you make the most of the LCGE. If you have multiple beneficiaries of your trust, you can use multiple LCGE. So, if you have three kids and a spouse, you can add a total of five people to your trust and take advantage of five LCGE. This means multiplying the individual LCGE limit, $1,016,836 by five and exempting that amount from taxation.
Proper tax planning and structuring of ownership can help maximize the benefit of the LCGE. This includes the timing of the sale, structuring share ownership, and meeting the requirements for a qualified small business corporation.
Watch the video on this topic
Now that you understand the ownership structure and benefits associated with an operating company, holding company, and family trust, you can use these entities to take your corporate structure to the next level. Book a call today and leave all the heavy lifting to us.
