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Set Up a Holding Company

When considering different structuring options for your business, you may have heard of the idea of having a holding company. However, it is important to understand what a holding company is and how it can benefit your business. They are said to be used in the corporate structure of a lot of businesses, however, you aren’t sure what a holding company is or why you should want one. Here we will be going over what a holding company is and why it may be beneficial to set one up.

What is a Holding Company?

For beginners, a holding company is an incorporated company that is usually used for holding investments, generally shares of another company. A holding company is a company created to buy and own the shares of other companies. These other companies are known as the subsidiaries of the holding company. The holding company usually does not produce goods or services or take part in the daily operations of the business. Instead, it often owns assets that subsidiary companies use. This differs from an operating company as they are used primarily for generating active businesses income.

Business owners usually consider setting up a holding company and one or more subsidiaries to help structure their business as it grows. Indeed, this is because the holding company can provide greater safeguards against risks and streamline operations for a business that is still growing and diversifying.

What are the advantages of a holding company?

There are a variety of reasons why holding companies can be useful for building or maintaining a business. Here we will list some reasons as to why you might want a holding company.

Asset Protection

One advantage that comes with having a holding company is asset protection. Placing operating companies and the assets they use in separate entities provides a liability shield. Holding companies can be used as an additional level of protection by transferring some of the assets of your operating business to the holding company. Since these assets are separate from your main operating business, they may be protected from creditors in the event something were to happen. The debts of each subsidiary belong to that subsidiary. A creditor of the subsidiary cannot reach the assets of the holding company or another subsidiary.

Additionally, a holding company provides a layer of separation between the ultimate shareholders and the operating business. In some instances, this may help protect personally owned assets, such as your family home, in the event of litigation against your operating company.

Where a holding company holds the valuable assets and is an entity separate from the operating companies, it minimizes the risk of losing those assets if the operating company performs poorly or becomes insolvent.

Even if you’re in a low-risk industry, many operating companies are inherently exposed to various risks through activities, and having a holding company in Canada may be a useful part of an overall protection plan for your assets.

Tax Benefits

Another advantage of having a holding company is related to multiple tax benefits that come alongside having one. A holding company can be set up to reduce the amount of tax that the group as a whole has to pay. Holding companies that own 80% or more of every subsidiary can reap tax benefits by filing consolidated tax returns. Assuming the holding company owns 80% or more outstanding shares of the operating company, the operating company can pay tax-free intercorporate dividends to the holding company. It’s possible to gain tax savings by investing these excess profits corporately rather than personally. Without a holding company, the shareholder would receive any excess profits paid in the form of dividends, pay personal income tax, and have less left over to invest.

Holding companies that own 80% or more of every subsidiary can reap tax benefits by filing consolidated tax returns. A consolidated tax return combines the financial records of all the acquired firms with that of the parent company. In such a case, should one of the subsidiaries encounter losses, they will be offset by the profits of the other subsidiaries. In addition, the net effect of filing a consolidated return is a reduced tax liability

The amount of tax savings can differ due to several possible factors that can include personal income, the type of income earned, and the province. Due to some recent changes in rules related to how much investment (or passive) income a corporation can earn, the complexity in achieving these savings has increased but it is still valuable to take any opportunities that arise.

Lower debt financing costs

A holding company that has financial strength can often obtain loans for a lower interest rate than its operating companies could themselves, particularly where the business in need of capital is a startup or other venture considered a credit risk. The holding company can obtain the loan and distribute the funds to the subsidiary.

Central Control

Usually, the management of the holding company and the subsidiary companies is controlled by the directors of the holding company. Therefore, this provides a cohesive and centralized management structure that allows the holding company to maximize its performance and growth.

Flexibility for Growth and Development

A holding company is also advantageous because it allows for greater flexibility. Specifically, having the valuable assets held by the holding company allows the group to:

  • diversify more efficiently
  • invest in new ventures; and
  • exit ventures if needed.

Operating companies can take these steps without putting the holding company or the group at risk. Moreover, a holding company gives greater power to the group and subsidiaries to invest in larger projects.

What are the downsides of a holding company-operating company structure?

Formation and ongoing compliance costs

Having a holding company in Canada can be an overall positive thing to possess when trying to grow your business. The most notable disadvantage is the initial set-up cost for a holding company and ongoing compliance. The holding company and each subsidiary that is formed require the payment of formation fees. There will also be, in most cases, annual reports and franchise tax obligations.

Holding companies have additional set-up costs and expenses that would come with owning a secondary company, including the costs of annual corporate tax compliance. Given the limited activity in a holding company, these compliance costs may not be significant and in most circumstances, the benefits would outweigh any compliance costs. 

Management challenges

As noted, a holding company does not have to own all the subsidiaries’ ownership interests. That can be both an advantage and a disadvantage. Where it does not own 100%, it will have to deal with minority owners. Sometimes conflicts arise when the interests of the minority owners are different from those of the holding company.

The fact that the holding company’s management does not have to be experts in the operating companies’ businesses can be a disadvantage because the holding company’s management may be overseeing and making major policy decisions for businesses or industries in which they are not particularly familiar.

Complexity

The use of holding companies and subsidiaries adds an element of complexity not found in the single-entity structure. holding company structure can be very complex, with many subsidiaries to keep track of. a good entity management system can be an invaluable tool in keeping track of all the important information, records, and due dates for all of the companies.

Failure to do so can increase the risk of a court piercing the veil and allowing a creditor to reach assets beyond the debtor subsidiary.

When should I set up one?

To determine whether you ought to set up a holding company, you should first examine your objectives. Holding companies can be beneficial if your operating company earns excess cash, allowing you to invest it and potentially defer some tax payments. If your operating company operates in an industry with litigious risk, and you have substantial personal assets, you may find it advantageous to establish a holding company. When it comes to setting up and maintaining the holding company, the biggest disadvantage can easily be overcome if you have the funds to cover the setup costs.

Final Words

Having a holding company in Canada provides advantages to a corporate group but it may not be a good idea for everyone. This is a complex issue, with liability and taxes to consider. Before you form a holding company, consult your accounting or legal professional for advice related to setting up a holding company in your circumstances, due to the number of legal and tax-related decisions you need to consider. Discuss your current situation and future to make sure everything you do is according to all federal and state laws and regulations.

With the correct advice, a holding company may just provide you with the financial tools to grow your business while providing tax savings, asset protection, and many other possible advantages. Filing Taxes is an accounting firm operated by professional Accountants in Toronto & Mississauga who specialize in helping individuals and corporations reduce taxes and tax planning. Feel free to contact us through our website filingtaxes.ca or reach out at 416-479-8532. Schedule your tax preparation appointment with us and take the first step towards proper management of your finances. Our professional personal tax accountants will make sure to get you the maximum tax refund on your personal tax return.

Frequently Asked Questions

What is the role of a holding company?

The purpose of a holding company is primarily to hold investments, whether they are corporations, partnerships, or limited investments. Holding companies may also hold properties like stocks, real estate, and patents.

What are the benefits of a holding company?

The main benefit that comes with having a holding company is being able to receive intercorporate dividends tax-free from operating companies, to potentially invest excess corporate profits. Additionally, a holding company provides a layer of separation between the shareholder and the operating company, which may prove useful in the event of litigation against the operating company. 

How do I start a holding company?

Once the decision has been made to use a holding company-operating company structure, the next question is how this structure is formed. To create a holding company, you should figure out whether having one is right for your situation and industry by speaking to a professional accountant. Once you know if a holding company is right for you then you can go about determining the optimal ownership for who will own the holding company. 

From there you should consider your financial resources and tools and decide if you want to incorporate the holding company provincially or federally by asking your accountant or lawyer. Once you have done all this you can start talking about the actual set-up process and how to create a bank accountant for your holding company as well as add assets towards it.

Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.

Salman Rundhawa
Salman Rundhawa
Salman Rundhawa is the founder of Filing Taxes. Salman provides valuable tax planning, accounting, and income tax preparation services in Toronto, Mississauga, Oakville, and Hamilton.

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