Creating a holding company (Hold Co.) can be a strategic approach for business owners looking to transform wealth into a legacy. Primarily, a Hold Co. does not produce any goods or services but holds assets in the form of investments. A Holding Company can also own shares of an operating company. It can offer numerous benefits such as tax savings and asset protection. This article will explore the key tax implications and outline the steps to setting up a holding company.
Setting Up a Holding Company
To determine if a Hold Co. structure suits your business, begin by reviewing financial statements and incorporation documents. If advantageous, you can convert an existing company into a Hold Co. through the process of renaming and amending articles. Here’s a step-by-step guide:
- Review Financial Statements & Incorporation Documents: Assess whether a Hold Co. structure is suitable for your business needs.
- Articles of Amendment: Amend the name of the existing company to transform it into a Hold Co.
- Complete Legal Opinions: Authorize the reuse of the original company name for a new Op Co.
- Incorporate the Op Co.: Process the articles of incorporation for the new operating entity.
- Issue Common Shares: The Op Co. should issue common shares to the Hold Co.
- Finalize Incorporation: Complete the incorporation process for the Op Co. and ensure both the new Hold Co. and Op Co. have synchronized year-end dates of December 31st.
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Two Options for Creating a Holding Company
There are two primary paths to consider:
- Conversion of an Existing Company into a Hold Co.: This method involves transforming an existing company into a Hold Co., and then incorporating a new Op Co.
- Section 85 Roll-Over: This technique involves a tax-deferred transfer of assets to a Hold Co. in exchange for shares. It requires the involvement of a professional tax attorney.
Tax Benefits of a Holding Company
Several tax advantages make holding companies an attractive option:
- Lifetime Capital Gains Exemption (LCGE):
A holding company structure can potentially help business owners qualify for the Lifetime Capital Gains Exemption (LCGE). This exemption allows individuals to offset up to approximately $971,190 of capital gains on the sale of eligible shares of a qualified small business corporation (QSBC). The use of a holding company may potentially help to qualify for LCGE, because of various “purification” strategies. You can reduce the number of assets held in the operating company that are not being utilized in an active business.
- Estate Planning:
Using a holding company can simplify estate planning. It allows business owners to utilize estate freeze, and issue common shares of the operating company to the holding company, facilitating ease of succession planning. This structure helps in transferring ownership and managing inheritance more efficiently, thus supporting long-term family business continuity.
- Asset Protection:
A holding company offers a significant advantage in terms of asset protection. By holding assets separate from the operating company, a holding company provides a shield against creditors and lawsuits directed at the operating business. This structure is crucial for protecting valuable assets from potential financial threats and legal actions.
- Tax-Free Dividends:
Dividends transferred between the operating company and the holding company can be done tax-free. This allows for efficient tax planning and enhanced investment potential, as funds retained in the holding company can be reinvested, increasing returns before personal taxes are incurred.
- Preservation of Small Business Deduction (SBD):
The holding company can be used to generate investment income, allowing the operating company to utilize the full Small Business Deduction (SBD) limit. This is important because the SBD Limit reduces the amount of corporate tax that a corporation needs to pay for up to $500,000 of income. Investment income over $50,000 can reduce the SBD Limit, leading to higher taxes, but a holding company structure mitigates this issue by separating the income sources. The SBD Limit is reduced by $5 for each $1 of investment income that exceeds $50,000 and reaches zero once $150,000 of investment income is earned in a year.
Drawbacks and Considerations
Despite the advantages, setting up a Hold Co. can be complex and requires professional advice to navigate the legal and tax nuances. Additionally, there are costs associated with setting up and maintaining a Hold Co., which should be weighed against the potential benefits.
Conclusion
The decision to establish a holding company should be made with careful consideration of both the financial implications and long-term strategic goals. For businesses looking to optimize tax outcomes, protect assets, and plan for succession, a Hold Co. offers a viable structure with compelling advantages. Click here to book a FREE Consultation and learn how we can help you organize finances, create wealth, and transform wealth into a legacy.
