Canada: Is Your Corporate Structure Right For Your Business?

Many small businesses are started with a very simple structure. Typically, the owners of the business are the sole shareholders of a single corporation in which the active business operations are conducted, which I will refer to as the operating company. In the event a business owner is conducting business as a sole proprietor and has yet to incorporate, it is likely a good idea to do so. As profits begin to accumulate, however, the structure of the company quite often isn't amended to reflect this growth. Effective corporate structures change with the growth of the corporation and can provide a multitude of benefits. One of the easiest and most beneficial ways of facilitating some of those benefits is by adding one or more holding companies to the structure of the business, granting the business owners increased risk minimization, wealth protection and tax minimization. Ultimately, these strategies keep more money in the pockets of the owners of the business.

A holding company is a newly created corporation whose purpose is to hold some form of property, be it land, buildings, or in this case, shares of the operating corporation. Instead of an operating company being owned and controlled by its shareholders in their name personally, the implementation of one or more holding companies in a business structure allows for those same shareholders to still own and control the operating company, this time through the ownership and control of a holding company which becomes the shareholder of the operating company. This effectively maintains the same ownership control over the operating company, but with several important added benefits:

Creditor Protection

By adding a holding company to the existing business structure, a business owner can take excess earnings the operating company may accumulate and transfer them to the holding company as a tax-free intercorporate dividend. If the operating company ever needs access to these funds, they can be loaned back to it from the holding company. This effectively allows the owners of the business to reduce the amount of cash in the operating company as much or as little as they prefer. Since each holding company is its own separate legal entity, the earnings moved out of the operating company to the holding company are no longer part of the operating company, effectively reducing exposure to creditors in the case of hard times or litigation against the operating company. Depending on the type of business carried on by the operating company, this could be an extremely important risk minimization tool.

Increased Investment Revenue

As discussed above, it is generally not advisable to keep excess cash, including investments, in an operating company due to creditor protection considerations if something unforeseen occurs which would put those funds at risk. Simply put, the more assets that a given corporation has the more that is subject to the claims of potential creditors or litigation. However, if the excess cash is paid out to the owner, by way of dividend or salary, the amount will be subject to immediate personal taxation and result in significantly less money to invest. If the entirety of the earnings are not needed for the personal use of the business owner, the operating company can transfer, again via tax-free intercompany dividends, to the holding company to invest these earnings away from the threat of potential creditors of the operating company, but still before they are paid out to the business owner and subject to personal taxation. This results in approximately 20% to 30% more money to invest with, as personal tax liability is successfully deferred until the cash is needed by the business owner.

There are no major drawbacks to this strategy, as a holding company can invest in anything that a business owner can and, in most cases, the annual investment income earned by the holding company is subject to taxation at a very similar rate as would be if the money were invested personally by the business owner. Given that most business owners do not have the benefit of a pension to fall back on and have to invest to create their retirement funds themselves, investing for retirement in this manner can be a significant boon to a savings fund.

Increased Flexibility

If more than one person owns the business, it is very common that the owners prefer to withdraw money from the business at different times. The implementation of holding companies to hold the shares in the operating company allows the owners of the business to move revenue out of the operating company and to the holding companies, but be paid out to each shareholder incurring personal tax liability, when the particular shareholder sees fit. This increased flexibility effectively allows a shareholder who doesn't immediately need the cash for their personal spending to safely leave it in their holding company to be invested without incurring personal taxation on it, or exposing it to creditor or litigation risk. The money can then continue to grow until it is needed by the business owner, at which point the holding company can declare a dividend to the business owner and transfer the funds. As previously mentioned, investing the pre-tax revenue will equate to a significantly larger sum of money down the road than paying personal taxes on it and then investing it.

Income Splitting

The term income splitting can be generally defined as the transferring of income from a high-earning family member to a lower earning family member to shift income into a lower tax bracket and thus reduce the overall tax burden to the family as a whole in a given year.

If a business owner has a family member in a lower income bracket, shares of a holding company can be given to that family member allowing dividends to be paid to them and subsequently taxed in a lower tax bracket, effectively reducing the overall tax burden to the family. By way of example, once children reach the age of eighteen they can receive approximately $15,000.00 tax-free in Manitoba which can be used as an effective way of providing for post-secondary education. Income can also be paid to minors, but will be taxed at the highest marginal tax rate, making this strategy best suited for lower income earning spouses or adult children.

Purification

As a tax incentive for small to medium-sized Canadian businesses, the Canadian Government offers an enhanced capital gains exemption for qualified small businesses. This exemption was increased to $800,000.00 in 2014 and is indexed for inflation thereafter. This means that when selling the shares of a business, subject to passing several tests, the shareholder is exempt from paying capital gains taxes up to the exemption amount, resulting in significant tax savings. One of these tests is that, at the time of sale, 90% of the fair market value of the assets of the corporation must be used to generate active business income. The use of a holding company to remove excess assets not used in active business, i.e. cash, can help ensure the business is "purified" and passes this test. It should be noted that there are several other considerations necessary to be eligible for the capital gains exemption, some of which are complex and may be subject to a waiting period prior to undertaking a sale of shares. Please let us know if you would like to discuss these considerations further.

Cost Considerations

Professional fees are required for incorporation as well as ongoing fees for annual legal and accounting maintenance. While these costs are generally easily offset by the benefits outlined above, consideration should still be given to the size of the business and the structure of the ownership of the business prior to determining if any alteration to your business is appropriate.

Closing

Each business, and the personal preference of the owners, is unique and the above considerations are just some that may benefit your business. Talk to us about whether the current corporate structure of your business is the right one.  

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Nelligan O'Brien Payne LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Nelligan O'Brien Payne LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions