A lot of business owners heard about the idea of having a holding company, but many do not really understand what a holding company can do, what the benefit is, and what the drawbacks are. This is a popular question that I get asked quite often. I will discuss the pros and cons of a Holdco so you can have a better understanding of a Holdco.
What is a Holdco?
A holding company is a type of business entity that primarily exists to own and control other companies’ shares or assets. In Canada, establishing a holding company can offer various benefits depending on your specific business objectives and circumstances. Here are some situations where having a holding company in Canada might be advantageous:
1. Asset protection: A holding company can help protect your business assets by separating them from operational risks. By holding the assets through a separate entity, you create a legal barrier that shields the holdings from potential liabilities arising in the operating companies. If you have a large amount of investments/cash or real estate property, having a holding company to hold these assets might be a good idea.
2. Tax-free Withdrawal of the Initial Investment from Business Acquisition: If you plan to purchase a business by acquiring a company’s shares, having a holding company to do the acquisition will make it easier to withdrawal your initial investment without paying personal taxes.
For instance, you are planning to acquire a car wash company for $1M through taking over 100% of this company’s shares. If you personally purchase the shares, this $1M investment counts toward the share price of the company. You will have to wait until in future you sell this company’s shares to withdraw this initial investment without paying any personal tax.
Alternatively, if you incorporate a holding company, and then lend this $1M personal money to your holding company as a promissory note and then the holding company acquire the car wash company’s shares. In future, when the car wash company has a profit, the profit can be distributed to the holding company through a tax-free intercompany dividend, and this money can be further distributed back to you through repayments of the promissory note. This way your initial investment can be repaid back to you sooner without any tax consequence.
3. Succession planning: Holding companies can facilitate succession planning by allowing for the transfer of ownership and control of the operating companies to the next generation or chosen individuals. It offers a centralized entity through which shares or assets can be transferred or distributed.
4. Investment vehicle: A holding company can be used as an investment vehicle to hold and manage various investments such as stocks, real estate, intellectual property, or other assets. This can provide a level of separation between your personal assets and your investment activities.
While having a holding company can provide you with various benefits, there are potential drawbacks or considerations to keep in mind when establishing a holding company.
1. No access to Lifetime Capital Gain Exemption (LCGE): It’s important to note that the capital gains exemption ($971,190 in 2023) is only available to individuals rather than corporations, including holding companies. Holding companies themselves do not qualify for the capital gains exemption because they are not considered individuals for tax purposes. In the above car wash company example, if the holding company acquires the shares, the owner will not be qualified to claim the LCGE when selling the company shares in future.
2. Increased complexity and administrative burden: Holding companies often require additional paperwork, legal formalities, and ongoing administrative tasks such as maintaining separate financial statements and records for each subsidiary. This can result in increased complexity and administrative burden compared to a simpler business structure.
3. Costs of establishment and maintenance: Establishing and maintaining a holding company may involve additional costs, such as legal fees, accounting services, and registration fees. These costs can vary depending on the complexity of your structure and the level of professional assistance required.
4. Limited liability protection: While a holding company can provide some protection for your assets, it does not offer absolute immunity from legal claims or liabilities. There may still be situations where creditors or claimants can pierce the corporate veil and hold the holding company liable for the debts or actions of its subsidiaries.
5. Restrictions on loss utilization: Holding companies may face restrictions on utilizing losses incurred by their subsidiaries. The ability to offset profits of one subsidiary with losses from another may be limited or subject to certain conditions and regulations. A reorganization including amalgamation or wind-up may resolve this problem.
Having a holding company is a big decision, it might involve restructuring of your current corporate structure, careful tax planning is required before taking any action. Please consult Streamline Accounting Professional Corporation if you have any questions.
If you have any questions, please reach out and book an appointment with our team.