Holding Companies – The Basics
You may have heard of the term “Holding Company” and wondered if it was something you needed. First off, what is a Holding Company in the context of this discussion? It would help to start off by describing what it is not – an ‘Operating Company’. An Operating Company (OpCo) is one that actively operates a business – for example, an incorporated local bakery engaging in retail sales. A Holding Company, by contrast, typically will hold investments – such as shares in an OpCo.
Benefits of a Holding Company
Imagine a successful OpCo accumulates profits over many years, and now has cash and investments retained in it. If this company, which is actively engaged with customers and its business activity, issued, they could theoretically be at risk of losing those assets. Instead, if the OpCo was owned by a Holding Company, those assets could have been moved there by way of a tax-free dividend. This would have added an extra layer of protection as the Holding Company is not engaged directly with customers or any business activity.
Possible Tax Planning and Deferral
Being able to move profits within a corporate structure has its benefits in tax planning, as well. In a scenario where an Opco is owned 50/50 by two unrelated individuals, there may be different ideas on what to do with their respective share of profits. The introduction of holding companies would allow for the payment of the profits by way of a tax-free dividend from the OpCo to the respective holding companies. Consider the scenario where OpCo earned $200K of net profit – and one shareholder wants his entire $100k while the other only needs $40k to pay the bills. This structure allows the partner who withdraws less cash from the corporate structure to defer a significant amount of tax.
Drawbacks of a Holding Company
Another corporation in the picture means more costs. Initial set up for a new corporation, as well as annual filing and maintenance costs, should be weighed against the potential benefits. There may be additional complexity because of the structure, so ensure proper planning is done.
Assuming the OpCo is a business that could potentially be sold someday, a Holding Company could complicate access to the Lifetime Capital Gains Exemption. If you’re interested in structures that allow for more flexibility surrounding the Lifetime Capital Gains exemption, please check back for our future article on the benefits of a family trust in the owner-managed business environment.
This has only scratched the surface of Holding Companies and their application – if you think you may benefit from such a structure within your business, don’t hesitate to reach out to your trusted T&A professional for more personalized info and analysis.