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Guides: Setting Up a Holding Company in Canada: Is It Right for Your Business?

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Guides: Setting Up a Holding Company in Canada: Is It Right for Your Business?

Explore the Strategic Advantages and Considerations of Establishing a Holding Company in Canada

Deciding whether to set up a holding company in Canada involves more than just understanding its definition; it requires a deep dive into how it can strategically benefit your business structure, tax obligations, and asset protection. This guide provides a thorough examination of holding companies, highlighting both the benefits and the complexities involved, helping you determine if this business structure is right for your entrepreneurial goals.

The Basics: What is a Holding Company?

In Essence, a Holding Company (“HoldCo”) is a regular corporation with the exact same attributes as any other corporation you may register. However, the intent use of a holding company is what differentiates it.

As we will discuss more in-depth, a holding company is usually a “parent company.” The main benefit of a holding company is to hold and/or manage assets and investments in other companies you may own directly or indirectly.

There is no limitation to what kind of assets a Holding company can own. Your HoldCo may own shares of your Operating Company (“Opco”), real estate, vehicles, yachts, investment portfolios, beneficiary to a life insurance policy, you know name it.

Different types of Holding Company Structures

It is important to note that when a HoldCo owns the shares of an OpCo, the OpCo is known as the subsidiary. There are endless possible structures you may develop when designing your corporate structure. Let’s discuss some more key terms:

Holding non-operating (“Pure”)

The most common type of HoldCo. This is when the HoldCo was made to solely own the shares of related Operating Company. These corporations have no operations and are used solely for the ownership of assets and/or transfer of non-taxable dividends between corporations to flow to the original shareholder.

Holding operating (“Mixed”)

An uncommon type of HoldCo. Holding operating corporations is when a corporation does not wholly own the shares of another operating company or the holding company owns an asset, often real estate or stocks, while also maintaining business operations. This often depends on the circumstances and goals of the business owners, though not recommended as it does not provide asset protection.

Subsidiary HoldCo

Another common type of HoldCo. In some circumstances, the OpCo may own the shares of the HoldCo, a reverse of what we mentioned earlier. In this case, the HoldCo will be a subsidiary of the OpCo (“parent company”). This can be done when money flows from the operating company into the holding company to purchase an asset. These transactions are transferred on a tax-free basis, though subject to interest-benefits calculated at the prescribed rate by the CRA.

Steps to Establish a Holding Company in Canada

Registering Holding Company in Canada

In Canada, all corporations need to be registered in a Business Registry. In Ontario, we have two registration methods. The corporation can be registered Federally by Corporations Canada or Provincially with the Ministry of Ontario.

From a tax point of view, there is absolutely no difference in tax treatment between them. In a future blog post, we will discuss the key differences in incorporation federally or provincially.

Naming a Holding Company

There is no legal requirement to name a Holding Company in a certain way. Creating a holding company is no different than registering a regular corporation. Though some common etiquette of naming holding are

  • LastName HoldCo
  • BusinessName HoldCo
  • FamilyName HoldCo
  • Numbered Company (recommended)

 

Overall, naming a HoldCo does not have any impact in a legal or tax perspective. It only aids in organizing the corporate structure web you may have in the future.

How much does a Holding Company Cost?

Holding Companies cost the same as any other corporation. Corporation Canada and Ontario Ministry have their own separate fees. Additional fees are charged when a customized name is chosen over a numbered company.

Professionals surcharge in addition to fees they pay on your behalf when creating a holding company. Please contact FShad CPA to register your first holding corporation.

Administration

As with all Corporations, Holding Companies are not exempt from filing their tax returns with the Canada Revenue Agency. Often overlooked, despite not having any income or operations, CRA requires holding companies to file their tax returns before their deadline.

It is also important to note, annual returns must also be filed with the respective registry. Failure to comply may risk your corporation being dissolved.

Advantages and Disadvantages of a Holding Company

Benefit of Holding Company

Asset and creditor protection

Routine activities of your operating company might expose your business to potential liabilities. To safeguard your assets from potential claims and creditors, consider using a holding company to hold excess earnings or real estate. Should your operating company face legal action or bankruptcy, assets typically managed by a holding company are generally protected from creditors, as each operates as a distinct legal entity.

Since corporation is it’s own separate legal business entity, creditors are unable to pursue you on your personal assets and assets held within other corporations. This is benefit of having a holding company is ideal for real estate as most investors intend to purchase each property separately held under a separate corporation to further diversify their protection on other projects. The credits will unable to pursue you on assets held with the holding company.

Tax savings and tax deferral opportunities

Holding investments within a corporation rather than personally can still offer tax savings, despite recent complexities introduced by changes to rules on passive investment income. The potential for savings varies based on several factors, including your province of residence, levels of corporate and personal income, and the nature of the income earned.

Income splitting opportunities

A holding company enables other family members to participate in the profits of the operating company by holding its shares. This arrangement allows them to receive dividends, which may be taxed at a lower personal rate.

However, income splitting, or income sprinkling, is governed by specific regulations. The Tax On Split Income (TOSI) rules restrict the kinds of income that can be distributed from a corporation to family members. To understand how these rules affect you, it’s advisable to consult with a qualified tax specialist.

Simplified estate planning

With a Holding Company, you can ensure that this wealth is transferred to your loved ones precisely as you intend.

Estate planning with a Holding Company requires a strategic evaluation of tax implications, inheritance strategies, business succession, investment choices, and legal requirements. Utilizing a Holding Company in your estate plan can significantly reduce or even eliminate taxes on investment income and capital gains while safeguarding your assets from creditors or legal disputes. This approach also offers considerable flexibility in how and when assets are distributed to beneficiaries.

A Holding Company enhances business continuity by establishing a clear framework for the transfer of company ownership in the event of death or retirement. For those eyeing future growth, a Holding Company not only simplifies securing financing options but also fortifies the protection of personal assets against business-related liabilities.

Through strategic planning and execution, integrating a Holding Company into your estate strategy stands as a potent tool for wealth preservation. It ensures the seamless transfer of your legacy to future generations, optimizes tax benefits, and enhances the overall benefits of your financial planning.

As we explore the potential for facilitating future expansion through a Holding Company in the next section, it’s crucial to recognize how this structure can benefit not only your current financial landscape but also your future endeavors.

Lifetime capital gains exemption

A key characteristic of corporations in Canada is the introduction and Utilization of the Lifetime Capital Gains Exemption (“LCGE”). It Is important to note, the lifetime capital gains exemption is only available to Canadian Controlled Private Corporations (“CCPC”). Put simply, the Lifetime capital gains exemption allows incorporated business owners with a tax-free capital gain of up to $1,016,8366 (2024). The real benefit is when the inclusion rate of 50% is used with the LCGE, which gives a net amount of $508,418 that can be used tax-free.

The LCGE is often used by business owners looking to sell their business shares or transition the business to their next of kin. To Qualify for the lifetime capital gains exemption, the shares being sold must be purified as Qualified Small Business Corporation (“QSBC”) shares. To qualify as QSBC shares, the following conditions must be met:

  • Asset test – 90% or more of the company’s assets must be used in active business (aka not holding passive investments) at the time of the sale.
  • Basic asset test -50% of the company’s assets must be used in active business (aka not holding passive investments) for the entire 24 month period before the sale.
  • Holding period test – The owner of the business must have held the shares for at least 24 months before the date of the sale.

Disadvantages of holding companies include

Incorporation Costs

Setting up a holding company involves certain expenses. It’s advisable to engage a lawyer to assist with drafting the incorporation documents, which, while beneficial, incurs a fee.

Before deciding to incorporate a holding company, it’s crucial to consider the costs against the potential benefits carefully. Analyzing whether the advantages, such as improved asset protection, tax efficiencies, and streamlined business operations, justify the initial and ongoing expenses will help ensure that the decision aligns with your business objectives and financial strategies. This thorough assessment will guide you in making an informed choice about establishing a holding company.

Ongoing costs

Maintaining a holding company also incurs recurring expenses. For instance:

  • Annual Legal Filings: A legal filing is required to maintain the company’s good standing each year. Typically, a lawyer’s fee to handle this filing is about $350 annually.
  • Annual Corporate Tax Return: Additionally, you’ll need to hire an accountant to prepare and file the annual corporate tax return, which generally costs around $2,500 each year or $500 for an inactive corporation
  • Bookkeeping: Bookkeeping must be completed before filing the corporate tax return. If you’re not managing this yourself, you will incur additional costs for these services.

Administration

As mentioned before, owning a corporation in Canada comes with administrative responsibilities. The holding company must file its annual T2 tax return and annual returns with the business registry.

HoldCo can pay more taxes.

When HoldCo holds certain investment assets, such as rental properties or stock portfolios, it will likely earn taxable income. In Canada, investment income, also known as passive income, is taxed at the highest tax rate, 50.17% (2024) in Ontario.

This is a complex topic. However, shareholders may receive a dividend tax credit when they pay taxable dividends from the corporations, which would reduce their corporate tax on a net basis.

Therefore, without proper planning, business owners may initially pay higher corporate tax through a holding company than they would had in personal tax.

Frequently Asked Questions

Recap: what’s the purpose of the holding company?

The primary function of a holding company is to own its investments, such as shares in other companies. This ownership structure is typically employed to generate investment income, aid in tax planning, or reduce risk.

Can a holding company own real estate in Canada?

A holding company can own a diverse range of assets, including real estate, publicly traded securities, bonds, and shares in private companies.

Although it’s feasible to include real estate within a holding company’s portfolio, this might not always be the most advantageous approach. It’s important to speak with your tax advisor to identify the most suitable strategy for your specific circumstances.

Do Holding companies file a Tax return?

Like operating companies, holding companies are also required to file an annual tax return. The deadline for filing is six months following the end of the fiscal year. However, any taxes owed must be paid within two months after the year-end.

Do holding companies pay taxes in Canada?

Holding companies pay tax on taxable income earned. Often Holding Companies would earn investment income.  This means that the tax rate applied can be significantly higher than an operating company or personal tax rate.

Insights about running a successful business.

Disclosure: This publication is produced by FShad CPA Professional Corporation as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.

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