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A holding company is a company that owns shares in another
company. If the holding company owns the majority of shares of
another company, it is also referred to as a parent company. It
generally does not produce goods or services itself. The sole
purpose of a holding company is usually to own shares in another
company.
The reasons for establishing holding companies are diverse. They
may be created to operate for a short period of time or as part of
a long-term plan. Whether it is better to form a holding company to
hold your shares rather than you holding them personally requires
significant consideration of your individual circumstances and
proper advice from qualified professionals. Factors to consider
include the nature and revenue of the business, the jurisdiction in
which the business owner resides, and the business owner's long
term goals. In this article I have outlined some of the benefits
and drawbacks associated with creating holding companies.
Advantages
Minimize Exposure to Risk
Holding companies may protect a business owner's interests
by minimizing exposure to risk and by keeping creditors at a
distance all the while reaping the benefits of the operating
company's goodwill. Subject to certain rules, you can remove
cash from an exposed operating company to a holding company on a
tax free basis. Business owners can take risks through the
operating company and limit risk to the operating company alone
rather than exposing the holding company. This is because the
holding company performs no transactions and therefore does not
move cash and other assets around. The holding company is exposed
to risk only to the extent of its investment in the operating
company. If a holding company lends money to the operating company,
it can secure the debt and become a secured creditor of the holding
company. This gives the holding company priority when it is time
for the debt to be repaid.
Tax Benefits
Depending on the percentage of outstanding shares held by the
holding company in the operating company, the dividends paid to the
holding company may be tax free.
For shareholders with a high marginal tax rate, a portion of
tax on dividends from taxable Canadian companies may be deferred
until dividends are paid by the holding company to the
shareholders.
You may be able to locate the holding company in a province
with a lower corporate tax rate.
Estate Planning
Holding Companies may help with succession planning by
facilitating the transfer of wealth to the next generation. Shares
in an operating company can be transferred to younger family
members through a holding company by way of an estate freeze,
structured to cap a person's tax liability upon his or her
death and transfer any future growth to family members.
Disadvantages
Set Up Costs
Holding companies require additional set up costs and these
expenses can be ongoing, including the cost of preparing annual
financial statements and corporate tax returns. Unless your shares
are of significant value, a holding company may not be
worthwhile.
No Tax Benefits or Negative Tax Implications
Any losses realized in a corporation are only available to
offset other income earned by the corporation.
Holding companies are not eligible for the $750,000.00 capital
gains deduction.
In some instances, if certain qualifications are not met, a
holding company can introduce an additional level of tax in
addition to any personal income tax on distributions from the
holding company. This is due to corporate tax on the income earned
by the holding company. Double taxation of the underlying income
may result.
To avoid the negative tax consequences associated with the
payment of funds from a holding company to a shareholder, tax
efficient ways of distributing funds to shareholders should be
considered. Mechanisms to mitigate or eliminate negative tax
consequences include the repayment of shareholder loans and taxable
dividends (which may result in a refund of corporate tax to the
holding company). More such tax minimizing mechanisms may be
available, depending on your circumstances.
With correct advice, holding companies may provide tax savings
and help you reach your estate planning goals. Individuals
interested in creating a holding company should first seek
assistance from a lawyer, accountant and/or other qualified
professional. These professionals will provide information and
advice customized to assist you with your particular situation.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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