When does it make sense to start a holding company?

If your Canadian business is accumulating excess cash and you’re looking to invest, incorporating a holding company may be the right decision for you. A holding company is created for the purpose of “holding” various assets such as real estate, shares in stock, bitcoin and even other businesses. It does not have active business income, it passively holds assets that generate passive income.

The registration process for a holding company is the same as any other company in Canada. Decide whether the company will be registered at a regional or a federal level.  If you want the company to have an official name, you will have to order a NUANS report to ensure that the proposed business name is available and not used by other people as a trademark or a corporate name. It is not necessary to have an official name, though. Instead, the corporation will be recognized by a unique number assigned to it by Corporations Canada. RBC Venture’s Ownr can enable you as you start, manage, and grow your business. Whether you’re registering or incorporating your first company or want to automate legal work for an existing business, Ownr has the tools your business needs. It has all the legal tools needed for growing businesses, including share management, employment agreements, corporate company updates and more.

Advantages of Holding Companies in Canada

Increased Asset Protection 

Having assets in a holding company, rather than an operating company, helps keep them safe from creditors just in case unforeseen circumstances arise. As a business owner, you can take risks through the operating company, rather than exposing the holding company, because the holding company doesn’t perform any transactions. You can move cash from an operating company to a holding company on a tax free basis.  

As the sole shareholder of the new holding company, you can transfer the ownership of the excess operating company funds to the holding company by way of a dividend. Since dividends between Canadian controlled private corporations (owned by the same person) are tax-free, you can move the money with no negative tax consequences. A holding company is only exposed to risk the amount of its investment in the operating company. 

An operating company is considered a subsidiary if it’s a corporation owned by a holding company. It will hold the bank and supplier debt, and all the other things that expose it to financial risk. It’s liable for all the headaches that can come from running a business.

Tax Benefits

The Small Business Deduction in Canada (SBD) allows Canadian-controlled Private Corporation’s (CCPC) to pay a lower rate of tax on their first $500,000 of active business income. For associated corporations, you can allocate a portion of that $500,000 limit to the other corporation, allowing them to take advantage of the lower rate. Your holding company does not have any active business income, but any passive income earned within the holding company might impact access to the SBD for the associated operating corporation. The first 

$50,000 of passive annual income in a group is okay, but anything above that comes with more complex rules and could cause you to actually pay more tax.

The operating company may be able to pay tax-free inter-corporate dividends to the holding company, which the holding company can keep. That profit can be held inside the holding company until sometime later when you actually need the money.  A holding company gives you control over the timing of whether or not you receive that income personally. This flexibility in the timing of income allows for tax deferral.

Also, depending on the percentage of outstanding shares (the number of stocks issued) held by the holding company in the operating company, the dividends paid to the holding company may be tax free. For a shareholder 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.

Lock in the Capital Gains Exemption

A valuable tax benefit available to a business owner is the Lifetime Capital Gains Exemption (LCGE), as it gives an individual taxpayer an exemption on the sales of shares, to a third party, of a Qualified Small Business Corporation (QSBC) of up to $892,218 as of 2021. 

  • Must sell shares of company – at time of share sale, must have 90% of assets within company
  • Pass the Holding Period Test – held the shares for at least 24 months
  • Pass the Holding Period Asset Test – over 50% of assets must have been used in an active operating business

 It’s possible that if a business has many years of operating successfully and accumulates a significant amount of cash held in investment accounts. If this grows too much, you would no longer qualify for the LCGE. If you get too close to the limit, set up a holding company so that you can trigger the capital gain while you qualify so that it won’t be triggered later when you don’t. This is known as ‘purifying’ the corporation so that it can qualify for the LCGE when sold as long as the time tests above are met. Transfer the shares to the new holding company at fair value, trigger a capital gain on that transfer, then use the LCGE to make the capital gain on transfer tax-free. At that point, the exemption is locked-in as the “cost” of those shares then becomes the fair value.

Estate planning

Holding companies can help ease succession planning, the transferring of assets or the ownership of a business to the next generation. For example, Dad Entrepreneur would like to bring his daughter into ownership of the business, while still maintaining control. Dad can carry out an estate freeze with the help of a holding company. Freezing Dad’s shares in the company allows him to make his daughter a shareholder and shift all the future growth to her. Dad can remain in control of the business for now, and shift it to his daughter over time.

Disadvantage of Holding Companies in Canada

Compliance Costs

Holding companies require set up costs, such as the incorporation fee, as well as other ongoing compliance expenses, including the costs of preparing annual financial statements and corporate tax returns. Unless your shares are of sufficient value, a holding company may not be worth the money and effort. Also, you may have to amend Articles of Incorporation of the Operating Company if the share structure wasn’t set up properly for a Holding Company.

Setting up a holding company in Canada can be advantageous if you have an operating company with excess cash and you’re looking to invest. We recommend consulting an accountant for advice relevant to your particular circumstances, as there are various tax-related decisions you need to consider. With the correct advice, a holding company may help you to grow your business empire while providing asset protection, tax savings and many other potential advantages.