What is a holding company, and when should I set up one?

Worrying about excess cash sitting idle? Well, worry not! You can always invest it by incorporating a holding company. A holding company is an ideal way for holding different assets, including stock shares, real estate, cryptocurrency, etc., without the requirement of an active business income. It is mostly used to hold assets that generate passive income.

Moreover, the registration for a holding company is like any other company. Although, you will have to register it either at a regional or federal level. For an official name, you will have to order a NUANS report to ascertain the availability of your proposed business name. Corporations Canada recognizes businesses through assigned unique codes which can be used instead of official names. In case of ordering an NUANS report, you must contact an accountant as it is not an easy thing to by oneself.

You can use RBC Venture’s Owner to initiate the process of managing and growing a business. It has all the tools you need to register, incorporate, or for legal matters as well. The legal tools include share management, corporate company updates, employee agreements, etc.

Advantages of Holding Companies in Canada

There are many advantages to holding a company in Canada. Some of which are as follows:

Increased Asset Protection 

Unlike any other company, the assets in a holding company are safe from creditors in the cases of unforeseen circumstances. Since a holding company does not involve in any transactions, you can take more risks in an operating company by moving cash in between on a tax-free basis.

A holding company is only exposed to risks in terms of its investment in the operating firm. In such a case where an operating company is owned by a holding company, it is referred to as a subsidiary. All the debts and financial risks are covered by the operating company.

Tax Benefits

Small Business Deduction (SBD) grants the Canadian Controlled Private Corporations (CCPC) to pay a lower tax rate on the first income of up to $500,000. This can be utilized by associated corporations to avail the advantage of a lower tax rate. However, the passive income of a holding company can impact the access to the SBD for the associated operating corporation. First passive annual income up to $50,000 is considered fine. However, if it increases beyond, the company experiences more complex rules, which may lead to paying more tax.

Holding companies can be used for tax deferral purposes as well. The operating company can pay tax-free inter-corporate dividends to the holding company and keep them there until required.

The tax-free dividend income also depends upon the number of outstanding shares held by the holding company. The tax on dividends from taxable Canadian companies can be deferred until the dividends are paid by the holding company, which can save shareholders with high marginal tax rates. To learn how these can benefit you, you must get some knowledge from an accounting firm before buying.

Lock in the Capital Gains Exemption

Lifetime Capital Gains Exemption (LCGE) is a tax benefit that gives an individual an exemption on the sale of shares to a third party of a Qualified Small Business Corporation (QSBC) of up to $892,218. Nonetheless, there is a criterion for this which is as follows:

  • Must have 90% of assets within the company at the time of selling shares
  • Pass the Holding Period Test, which means holding the shares for at least 24 months
  • Pass the Holding Period Asset Test, which means that over 50% of assets should have been in use by the active operating business

Any business might end up having a lot of cash in an investment account after years of operating. This may become ineligible for LCGE if it crosses a limit. A holding company could be set up in this case to trigger the capital gain, which is known as ‘purifying’ the business for its qualification for the LCGE. The shares can be transferred to a new holding company at fair value at the time of selling, which will trigger a capital gain. LCGE could be used to make this transfer tax-free. At this point, the exemption is locked in as the cost then changes to the fair value of the shares later.

Estate planning

Holding companies can also assist in easing a succession plan. For this purpose, an estate freeze could be implemented, which would maintain the control of the shareholder in the company while he/she can shift the ownership to the next generation in due time. You must have all the documents ready at any time so your property may should not be freezed or something like that, it is best option to give your documents to the bookkeeper.

Disadvantages of Holding Companies in Canada

Compliance Costs

There are a few setup costs, including incorporation fee, ongoing compliance expenditure, etc. Nonetheless, this cost is insignificant if the shares are worth way more. The Articles of Incorporation might also need modification if the share structure is not set up properly initially.

Hence, a holding company in Canada can be beneficial if you are looking to invest a significant amount of idle cash for asset protection, tax savings, and other benefits.

Written By:
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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