How to make it rain with your holding company
If you’re a business owner, you may have heard of holding companies. Besides being trendy, what’s the hype about holding companies and do you need one?
Let’s start by defining what’s a holding company.
A holding typically owns shares in another company. Depending on the amount of shares owned, it could be referred to as the parent company if it’s a majority shareholder. It’s different from an operating company in the sense that the holding does not offer services or produce goods; it’s mostly used to own shares in other companies and keep the excess earnings from your operating companies.
Why would you need a holding company in your corporate structure? There are several benefits of using a holding such as tax savings; added protection against creditors and it’s an effective tool for estate planning strategies.
When you own the shares of your business directly, any dividends issued from the company to you will be taxable in your hands that year. If you have a holding company which owns your shares in your business, any dividend issued to your holding will be, in most cases, tax free for your holding. I won’t get into the details here but both the holding and operating company must be « connected » in order for the holding to benefit from this deduction. You can then decide when to pay yourself and how much. It's also useful when there are several shareholders in the operating company.
By having the excess earnings from the business paid up as tax-free dividends to your holding, the money can be used to purchase investments such as real estate or be reinvested. Depending on your business and situation, assets purchased by the holding company could be leased back to your business (the operating company). If you operate in an industry that is risky when it comes to lawsuits, by using this strategy the assets would be out of the reach of potential creditors and liability claims made toward your business.
When selling your business: If you own a business that you intend to sell, you could benefit from the capital gain deduction if your shares qualify. There are several conditions to be eligible but one of them is that throughout the 24 months preceding the sale, more than half of the company assets are used actively for the business. In the event that too many assets are not being used for the commercial activities, you could create a holding to which these assets would be transferred, this method is called "purification". (Doesn’t it sound very holy?)
When acquiring a company: If you wish to buy someone’s business, making the acquisition through a holding company is an optimal strategy in the sense that you do not have to personally take on the significant debt needed to proceed and this reduces the cost of financing also. It is better to buy the shares with dollars taxed at a lower rate than your after-tax dollars. The estimated time for repayment will also be longer if you have to pay yourself.
When used appropriately, holding companies are an effective vehicle for tax planning.
Still debating whether you need a holding company or nah? Just give us a ring.