Holding company: Is it the right option for you?

01 November 2022 by National Bank
A woman entrepreneur manages finances of her business

Prior to 2019, entrepreneurs were often advised to create a holding company because of the tax environment at the time. But things have evolved, and holding companies aren’t the go-to solution they used to be. Read on to find out if a holding company is still a good option for you.

What is a holding company?

To understand the concept of a holding company, let’s first compare it with an operating company. Your primary business—the one that provides your clients with products or services—is an operating company. It has its own set of taxes and regulations as well as advantages and disadvantages. 

The holding company is independent. It does some of the financial work your operating company doesn’t do. Its purpose is to group your passive income (e.g., investments, interest, dividends, etc.) under another entity.

Here’s an example: 

A dentist partners with two other colleagues to open a clinic. The three associates have an equal share in the operating company. Since the company’s revenues are divided three ways, the dentist could use a holding company to manage their share of the investments, interest and other dividends from the dental clinic.

How much does a holding company cost?

A company’s operating costs vary greatly depending on factors such as its size, complexity and structure. Other costs can include accounting, legal and tax services. It’s also important to consider the company’s annual registration or incorporation fees, which can cost you between $2,000 and $4,000 a year. To decide if a holding company would be right for you, it can be a good idea to do a cost-benefit analysis.

What are the benefits of a holding company?

Before the law changed, the main benefit of a holding company was the considerable fiscal advantage gained, i.e., paying less tax. At the time, a holding company was comparable to a personal RRSP: It sheltered your money so you could earn more interest on it. The rules have changed since then, but there are still advantages to having a holding company, depending on your situation.

Protecting your assets 

When a company has significant profits that need to be distributed among various shareholders, it can be a good idea to transfer the money to a holding company. This protects the company’s profits from creditors.

By using an individual holding company, a shareholder can also have more control over their personal share of the profit. Each shareholder in a company may have different financial goals. For example, through a holding company, a shareholder can use their shares to finance new business projects or their retirement. In other words, not having a holding company can reduce your decision-making power over your company shares. If you have personal plans that involve your share of the profits, having control over that share can make a big difference, especially when it comes time to draw down your investments for your retirement.

Spreading your income over several years instead of paying tax on it all at once

It can also be beneficial for small- and medium-sized businesses to consider corporate and personal income tax as a whole. In some cases, having a holding company may be useful for reducing your personal income tax. Shareholders would then receive their dividends gradually, based on an appropriate plan, and therefore pay less tax.

The holding company can also be a tool for revenue control when you don’t need large sums of money right away. Good planning can help you maximize your tax credits or other government programs. It’s worth reassessing your situation at each key milestone in your life.

Note that income from the holding company’s investments will be taxed at the highest rate until withdrawn.

Paying less tax on substantial profits

If you’ve already used your other registered accounts, you can pay less tax by moving some of that money to a holding company instead of paying it out to yourself as dividends. Basically, if you’ve used all your RRSP, TFSA, RESP, RDSP and FHSA contribution room, and you still have surplus income you were going to make a non-registered personal investment with, a holding company could be a good option for you.

Good to know : If you haven’t used up all of your RRSP, TFSA and RESP contribution room, it makes less sense to have a holding company.

Preparing to sell your operating company

Not everyone is familiar with the concept of a capital gains deduction from the sale of a business. When a business is sold, some Canadian entrepreneurs can deduct a significant amount of the capital gain from their taxable income—several hundred thousand dollars, in fact. To be eligible, the company being sold must have been using at least 50% of its assets directly in the company’s operations for the past two years or more, and at least 90% at the time of sale.

This works well if you have an operating company with an active core business. However, if your company is diversified and earns passive interest income from investments, or rental income from real estate, for example, you may not be eligible for the capital gains deduction. This is also true if your company has a lot of money in the bank.

Note that you would have to pay tax on the gains from the sale of those company assets. Removing all passive income streams, for example investments, interest or dividends, from your operating company and putting them in a holding company can be a good way to get around that. Generally, buyers are more interested in the primary operating portion of your business than its investments.

Since it can take time to move assets, it can be a good idea to separate out the company’s activities and put passive income in a holding company, even for a business that’s not going to be sold immediately. This can be good practice for several reasons: 

  • If something unexpected happens, like a disability, and you have to sell, it’s better to be in a position to take advantage of the capital gains deduction.
  • If a competitor offers to buy your business at a high price and the offer seems appealing, the sale would be even more advantageous with the deduction.

If you’ve been running your business for a number of years, you may have a holding company that it no longer makes sense to have, or it may still be an excellent tool for your business. Make an appointment with an advisor to figure out whether a holding company still is, or could be, a good way for you to manage your money, especially since the Morneau reform.

Have questions? We’ve got answers.

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