Before we answer that questions, we need to undertand what a holding company is.
What is a Holding Company?
A holding company is a separate legal entity that’s primary purpose is to hold investments. This is much different than an operating company, which is used to run an active business like a retail store or restaurant.
So what can a holding company actually hold? It can own a few things, like
- Commercial or residential real estate
- An operating company (for reasons I will get into down below)
- Public equities like Amazon or Google and interest earning investments
Now that we established what a holding company is and what it can own, why would we set one up?
- Creditor Protection – Earning excess funds in your operating company and transferring them to your holding company keeps them safe from creditors in the event of bankruptcy or a lawsuit.
- Capital Gains Exemption (CGE) – Setting up a holding company can help meet the criteria that needs to be met to obtain this exemption.
- Saving Taxes – By holding investments in a holding company, you can have a lower tax rate as opposed to holding them personally.
- Estate Planning – If you are thinking of transferring your business to your family, it could be beneficial to setting a holding company up.
Let’s go over an example of where it could be beneficial to setting up a holding company
Barbara runs a pizzeria in Niagara-on-the-Lake called Pizza by the Lake. It’s a successful business than earns $300,000 a year and everything stays invested inside the operating company. One day a cook accidentally spills a chemical into the pizza dough and all the customers eat it that day and everyone get’s food poisoning. They all file a lawsuit for $500,000. That excess cash and investments that has stayed inside the corporation is now at risk of having to be paid out for damages.
If Barbara had been transferring all excess profits tax-free into a holding company, the plaintiffs that are suing would have a difficult time obtaining the funds.
Disadvantages of Holding Company
Now, there can also be some disadvantages in having a holding company.
- Increased Complexity – It can be difficult to keep on top of how your assets are held which adds a new level of complexity.
- Start up Costs – It costs money to incorporate. If you use a lawyer or not there are going to be costs of setting up a holding company.
- Yearly Costs – Every year you will need to file a corporate tax return so there are yearly fees for that.
What if I Currently Have a Holdco?
If you already have a holding company in place with assets inside the company, the planning you need is very complicated and way beyond the scope of this blog post. Your accountant will likely suggest, a butterfly, freeze transaction, the payment of a taxable dividend or use of a stock dividend but like I said, this is a very complicated topic that is fact based on your specific situation.
Now that we know what holding companies are used for and a better idea of when to use, if you have any questions regarding any of this don’t hesitate to reach out. We are here to help you.