What is a holding company in Canada (1)

What is a holding company in Canada [7 Practical Examples]

“What is a holding company in Canada?” This question often arises when discussing business structures and investment strategies.

A holding company is an incorporated company that primarily focuses on holding investments. It differentiates itself from operating companies that actively run businesses. The following features and characteristics define what a holding company is:

Holding companies are primarily used for holding various forms of investments, such as:

  • Shares in public companies like Apple and Facebook
  • Interest-earning investments, including cash, GICs, term deposits, and bonds
  • Real estate assets, including residential and commercial rental properties, as well as land
  • Shares in private companies, such as a local incorporated plumbing business

Holding company is different to an operating company.

Unlike operating companies that are involved in running day-to-day business operations, holding companies specialize in holding and managing investments. They serve as custodians of diverse investment portfolios.

Holding companies leverage their expertise to strategically grow and diversify their investment holdings. By carefully managing their investments, holding companies generate income and increase their wealth through various investment avenues.

In the context of Canada, a holding company serves as a powerful tool for individuals and businesses, offering a range of benefits and opportunities. A holding company, also known as a “parent company,” plays a pivotal role in various aspects, including:

What is a holding company in Canada (2)

Asset Protection

  • Hold assets within a separate entity, distinct from the operating company.
  • Safeguard valuable assets from potential risks, such as creditors or unforeseen events.
  • Preserve asset value and shield them from potential threats.

Tax Advantages

  • Strategically structure investments within the holding company to capitalize on tax savings.
  • Benefit from potentially lower tax rates for corporations compared to individuals.
  • Reduce tax liabilities and maximize financial resources for long-term growth.

Tax Deferral

  • Manage income timing and flexible investment strategies to defer taxes to future periods.
  • Optimize cash flow and investment opportunities through tax deferral strategies.
  • Maintain financial flexibility by meeting tax obligations at the most opportune times.

Estate Planning and Succession Planning

  • Utilize holding companies to facilitate smooth asset and ownership transfers.
  • Ensure the preservation and continuity of businesses and family wealth.
  • Establish a structured framework for transferring assets to the next generation.

Holding Company Examples

1. Asset protection from a holding company

Operating companies face risks in everyday business activities.

Transferring assets to a holding company provides protection against creditors.

For example, Bob’s Building Co, a medium-sized construction company, faced a lawsuit due to faulty electrical equipment in an office building. Bob’s Building Co transferred assets to a holding company to safeguard investments from potential creditors.

2. Help claim the lifetime capital gains exemption

The Lifetime Capital Gains Exemption offers tax-free capital gains to owners of Canadian Controlled Private Corporations

Criteria for claiming the exemption:

  • Asset test: At least 90% of the company’s assets used in active business.
  • Basic asset test: 50% of the company’s assets used in active business for the entire 24-month period before the sale.
  • Holding period test: Owner must have held shares for at least 24 months before the sale.

For example, Aviato Inc., a Canadian Controlled Private Corporation, developed a software application and earned profits of $250,000 over four years.

Although Aviato Inc. initially failed the basic asset test, a holding company was incorporated to meet the requirements.

The holding company allowed for a tax-free dividend transfer and met the asset test criteria, enabling the owner to claim the exemption.

3. Tax savings from a holding company

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Holding investments in a corporation instead of personally can result in tax savings.

Considerations for tax savings:

  • Recent rule changes have added complexity, but opportunities for savings remain.
  • Factors influencing tax savings: province of residence, level of corporate and personal income, and type of income earned.

Meet Harvey Spectre, a highly successful lawyer based in Calgary. His employment income from Spectre Legal amounts to $350,000 per year. Harvey earns an additional $50,000 each year from his investment portfolio. The investment income subjects him to an extra $24,000 in taxes.

Holding company to the rescue!

Harvey incorporates a holding company to manage his investments. The holding company’s lower tax rate ultimately reduces his tax liability. In this way, Harvey saves nearly $5,000 through strategic tax planning.

4. Tax deferral from a holding company

Holding companies offer flexibility in timing income and deferring tax liabilities.

Let’s take the example of Sterling Cooper Inc., an advertising agency in Toronto. Three individuals: Don, Bertram, and Roger operate the company.

The company plans to distribute $100,000 dividends to each owner in 2019.

Don’s situation:

Don has high taxable income in 2019 due to a side gig as an actor. He expects no acting income in 2020 and prefers the dividend next year.

Again, holding company comes into action.

Don establishes a holding company to hold his shares in Sterling Cooper Inc. The dividend is paid to the holding company in 2019, avoiding taxes. Don can then receive the dividend in 2020, reducing his tax bill.

5. Capital preservation and wealth accumulation

Let’s explore a scenario where a holding company acts as a protection layer.

Michael Anderson, a seasoned investor located in Toronto, has successfully built a diverse portfolio comprising stocks, real estate, and various other assets. To enhance his asset protection and risk management strategies, Michael decides to establish a holding company.

The primary advantage of incorporating a holding company is the added layer of protection it offers for his personal assets. By keeping his investments within the holding company, Michael effectively separates his personal wealth from potential liabilities that may arise from his investment activities.

This separation helps safeguard his personal finances and provides a level of security in the event of unforeseen circumstances.

Additionally, the holding company structure enables Michael to employ tax planning strategies that contribute to the accumulation of wealth.

By reinvesting profits within the holding company, he can defer taxes on investment gains and capitalize on the power of compounding over time.

Furthermore, the holding company structure provides Michael with the flexibility to strategically allocate his investments. By carefully analyzing market conditions and evaluating opportunities, he can optimize returns and preserve capital.

6. Succession planning

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A Holding company is also very beneficial in context of succession planning.

Let’s take an example of Emma who runs a family owned business.

In order to secure the future of her family-owned manufacturing business in Alberta, Emma Roberts takes a strategic step by establishing a holding company.

This allows her to smoothly pass on ownership to her children as she nears retirement.

By incorporating a holding company, Emma ensures a seamless transition while maintaining the stability of the business. It’s like creating a solid foundation for the next generation to build upon.

With this structure in place, Emma can actively involve her family members in the business and preserve their shared legacy. It’s a thoughtful approach that combines practicality and sentimentality.

By carefully planning the succession process, Emma empowers her children to take on leadership roles and gradually acquire ownership interests. Through the holding company, Emma not only safeguards the business but also creates a pathway for intergenerational wealth transfer.

It’s definitely a smart move that sets her family up for long-term success.

7. Optimized tax structures for professionals

Holding company also helps in efficient tax planning.

Meet Dr. Benjamin Collins, a successful physician in Montreal. To optimize his financial situation, he incorporates a holding company. This decision brings him a range of benefits, including flexible tax planning and strategic wealth management.

With the holding company, Dr. Collins can efficiently manage his income, allocate funds for expansion and retirement planning, and explore diverse investment opportunities.

In essence, the holding company structure empowers Dr. Collins to manage his professional income efficiently, minimize taxes, and build a solid foundation for his financial future.

Disadvantages of a Holding Company

While holding companies offer numerous advantages, it’s essential to be aware of the potential disadvantages and carefully evaluate them before incorporating. These drawbacks often mirror the considerations involved in deciding to incorporate a business. Let’s explore these aspects:

Incorporation Costs

Establishing a holding company incurs initial costs, including legal fees for drafting the incorporation documents.

It’s crucial to weigh these costs against the anticipated benefits and long-term advantages of having a holding company.

Ongoing Expenses

Holding companies entail recurring costs that need to be factored into the financial analysis.

Annual legal filings – to maintain good standing, an annual legal filing is required, typically costing around $350 with the assistance of a lawyer.

Annual corporate tax return – hiring an accountant to file the corporate tax return averages around $2,500 per year.

Bookkeeping – depending on the complexity of the company’s financials, professional bookkeeping services may be necessary, adding additional costs.

Administrative Burden

Similar to operating companies, holding companies require regular legal and tax filings, demanding time and attention from the company owner(s).

It’s important to consider the administrative workload and ensure the availability of resources to fulfill the obligations associated with maintaining the holding company’s compliance.

Complexity and Professional Assistance

The utilization of a holding company introduces an added layer of complexity to one’s business and financial structure.

Without proper organization and oversight, individuals can lose track of how their assets are held, leading to a convoluted web of corporations.

This complexity often necessitates reliance on expensive professionals for corporate structuring and simplification, incurring substantial costs.

Tax Considerations

Although holding companies can offer tax advantages, improper planning can lead to unintended consequences.

Holding investments within a corporation might result in higher tax liabilities compared to personal ownership.

Careful tax planning and consultation with tax professionals are crucial to minimize tax burdens and ensure optimal tax efficiency.

By being aware of these potential disadvantages and taking proactive steps to address them, individuals can navigate the complexities associated with holding companies effectively. Thorough evaluation, sound financial planning, and expert advice contribute to mitigating risks and maximizing the benefits of incorporating a holding company.

What is a holding company in Canada? – FAQs

Here are some quick answers to commonly asked questions regarding holding companies:

What is the difference between a Holding Company and an Operating Company

A holding company is a non-active entity that holds investments, such as company shares, interest-earning investments, or real estate.

In contrast, an operating company directly conducts an ongoing business.

For example, Avalon Accounting Inc. is an operating company that runs an accounting firm, while Paul Sharpe Holdings Inc. would be a holding company that owns shares in Avalon Accounting Inc.

What is the primary purpose of a Holding Company

The primary purpose of a holding company is to hold investments, such as shares of other companies.

Holding companies serve various functions, including earning investment income, facilitating tax planning, and minimizing risk.

Benefits of a Holding Company

One major benefit of a holding company is risk mitigation. By having valuable assets held by a separate entity, the operating company’s exposure to asset loss due to litigation or insolvency is minimized.

Holding companies also offer greater flexibility for tax and estate planning purposes.

Starting a Holding Company

In Canada, starting a holding company involves creating a corporation, which can then be used as a holding company. There are resources available online, such as articles on creating a corporation or incorporation services.

Ownership of Real Estate by Holding Companies

Holding companies have the ability to own various types of assets, including real estate, publicly traded securities, bonds, and shares in private companies.

However, whether holding real estate in a holding company is the best option depends on individual circumstances. Consultation with a tax advisor is recommended to determine the most suitable solution.

Tax Obligations for Holding Companies in Canada

Yes, holding companies in Canada are required to file annual tax returns, just like operating companies.

The tax return is due six months after the year-end date, with any taxes owed payable two months after the year-end.

Holding companies are taxed on their taxable income, often consisting of investment income. Consequently, the applied tax rate can be notably higher compared to that of an operating company.

Understanding the nuances of holding company taxation and complying with filing requirements are important aspects to consider when managing a holding company in Canada. Seeking guidance from tax professionals can help ensure proper adherence to tax regulations and optimize tax strategies.

Final thoughts

To conclude, a holding company is an incorporated entity that focuses on holding investments rather than running active businesses. It serves as a custodian for various investments such as shares, interest-earning investments, and real estate assets. Holding companies offer advantages like asset protection, tax optimization, tax deferral strategies, and estate planning benefits.

In Canada, holding companies are valuable tools for optimizing financial situations, preserving wealth, and ensuring a solid foundation for the future. However, understanding the nuances of holding company taxation and complying with filing requirements are important for proper management. Seeking guidance from tax professionals can help maximize the advantages and minimize the risks associated with holding companies.

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