Clients who own businesses or hold investments may wonder if they should use a holding company to do so. Several factors must be considered here.
First, a holding company can be a company that does not produce goods or services but holds shares in the operating company. “The holding company is simply between the business owner and the active business, which allows profits to flow upwards and remain in the holding company, or the holding company can hold securities or rental properties, rather than the individual customer holding those investments.
Use a Holding Company-Operating Company Structure One of the reasons business owners use a holding company is for asset protection.
If a creditor of the operating company decides to sue the opco, [the creditor] could theoretically use all of its assets. ” By transferring excess cash or investments that are not needed for business operations to the holding company, assets are protected.
Another reason to use an opco-holdco structure is for tax planning. The opco may be able to pay tax-exempt intercompany dividends to the holding company, which the holding company can keep. This income can be kept within that holding company until the following year when you actually need the money as a business owner.
When using a holding company, you have more control over when individuals receive income. This flexibility is also more pronounced especially when multiple shareholders hold shares in opco through their respective holding companies. While Opco can pay tax-exempt intercompany dividends to each holding company, each shareholder can decide when to withdraw funds from his individual holding company based on individual tax circumstances. By contrast, there is no way to prevent current income taxes when dividends are paid directly from operating companies to individuals.
However, there is a caveat to intercompany dividends: the new anti-avoidance rules may treat intercompany dividends in excess of retained earnings as capital gains. Expert tax advice may therefore be required to determine the amount of dividends that can be safely paid, it said.
Other reasons to use a holding company include protecting U.S. investments from U.S. estate taxes, acquiring a company in a tax-favorable manner, or imposing an estate freeze. Portfolio transfer to holding company
The impact of SBD on holding companies
Another thing to consider here is the potential loss of the Small Business Deduction (SBD Small business deduction) when first being integrated by a business structure. “The new rules for 2019 indicate that if your passive income exceeds $50,000, you may lose the federal and most provincial provincial small business tax rates of five to one, and the SBD drops to $150,000 on investment income Zero. In addition, the SBD dollar limit must be shared among affiliated companies. Therefore, an investment in a holding company affects the ability of the associated operating company to claim the small business tax rate
Should individual investments be transferred to holding companies?
Another thing to look out for is whether an investment that is already personally owned should be transferred to a holding company if it is for tax purposes. The answer is usually no, because of negative tax integration costs. “In all provinces in Canada, there is actually a tax cost to earning investment income within a private company compared to individuals earning the same investment income. To calculate tax costs, when after-tax income is paid to shareholders, compare the income earned by the holding company The combined tax rate on investment income (interest) and dividends versus the tax rate on investment income earned by individuals (based on 2019 combined federal and provincial/territorial tax rates and assuming customers are taxed at the highest marginal tax rate). Taxes on investment income earned by holding companies Costs range from about 2 percent in Nunavut to nearly 8 percent in Nova Scotia, while capital gains are half those percentages.
Therefore, taxing the holding company’s investment income is always unfavorable (or neutral, as far as Canadian dividends are concerned), and putting existing investments into the holding company usually doesn’t make sense for tax deferral purposes, as it is not related to the individual earning the investment income. In contrast, there are usually no tax-deferred benefits. Specifically, if the holding company receives dividends from opco, it can be costly to withdraw that money, whether paid out as an eligible or non-eligible dividend. Also note that for dividends paid by the holding company to related parties, taxation of split income should not apply if the holding company is a “pure investment company” and does not carry on business. However, it said it may require professional advice to determine whether a holding company is in business.