January 25, 2021

What are the Benefits of a Holding Company?

When your operating company generates surplus cash, it can be advantageous to establish a holding company. This consists of inserting a new company between you and the operating company by transferring ownership of your company to the new company. From then on, the holding company controls the operating company, while you control the holding company, as illustrated in the following example:

The establishment of such a structure entails additional legal and accounting expenses, including, among others, incorporation fees, the cost of maintaining the minute book, as well as expenses for preparing financial statements and tax returns.

To ensure that the advantages of establishing a holding company outweigh the related costs, the holding company has to be formed at the right time. This generally occurs when the company generates a lot of cash and possesses property likely to increase in value.

In such cases, establishing a holding company will provide many benefits, the most significant of which are covered in this article.

Transferring Surplus Funds without Tax Consequences

The operating company can transfer its surplus funds to the holding company through intercorporate dividends, which are subject to advantageous taxation rules. In fact, the payment of an intercorporate dividend has no tax impact when the holding company controls the operating company or when it owns more than 10% of its voting and value shares. In such a case, the surplus funds can be transferred to the holding company via dividends and tax will be payable only when the holding company, in turn, pays out a dividend to you. This means that surplus funds not needed for company operations or to meet your personal needs can be kept in the holding company and invested. However, you must make sure that you keep sufficient funds in your operating company to meet the solvency test requirements of the Business Corporations Act and, in the case of a company governed by the Canada Business Corporations Act, the solvency and accounting tests.

The holding company also enables a certain degree of flexibility when the operating company is owned by several shareholders. Each individual can own their shares through their own holding company and, when the operating company pays a dividend to the holding companies, each individual can, depending on their personal needs, either pay themselves a dividend or keep the amount received in the holding company to invest it. This allows each individual to receive funds and pay taxes on them at their own pace.

Protection against Creditors

By transferring surplus funds to your holding company, this money will be in a separate estate from that of the operating company and will thus be shielded from the operating company’s creditors in the event of litigation.

In addition to keeping surplus funds safe from creditors, it is also possible to transfer to the holding company, without tax consequences, assets that are appreciating in value. This is what is called the “rollover” or transfer, by the operating company, of an asset to the holding company in exchange for the latter’s preference shares, whose redemption value equals the fair market value of the asset. The tax will thus be postponed to the time of the disposition of the preference shares.

A rollover may occur, for example, in a situation in which a building is owned by an operating company and used for its business operations. The building could be transferred by rollover to the holding company and the latter could lease the building to the operating company. The rental income could then be used to cover the building’s management and mortgage fees. This will create net worth in the holding company, which will be shielded from the creditors of the operating company.

Protection of Small Business Corporation (SBC) Status

An individual is entitled to a capital gains exemption when they sell shares of a small business corporation (SBC). For your operating company to qualify as an SBC, it must meet certain criteria, one of which stipulates that 90% or more of its assets must be used in the active operations of the company at the time the shares are sold. It may be necessary to “purify” the company before the disposition of shares to remove assets from the operating company that are not being actively used in the company’s operations, and the holding company can be used to transfer the excess assets from the operating company. Of course, it is important to consult a team of professionals to be sure that all the conditions required to take advantage of the capital gains exemption are met.

Acquisition of Another Company

A holding company may be useful during a leveraged buyout. In fact, if you want to pursue a business acquisition and this acquisition is wholly or partially financed by a loan, it is advantageous to do so through a holding company. Indeed, the principal part of the loan can be paid back from the intercorporate dividends that the holding company receives and interest on the loan can be deducted from income. This interest could also be deducted from the income of the operating company acquired if the latter merges with the holding company.

As you may have noted, a holding company is not created for the purpose of engaging in business activities, but rather to own shares or assets in order to, among other things, earn income from them in the form of dividends or rent or to shield funds and other assets from creditors. Given the expenses generated by the creation of a holding company, the usefulness of such a company depends on your needs and your company’s situation. The team at Calex Legal can work with your accountant to give you advice and assistance in the establishment of such a structure.

This note contains general legal information and should not be used as a substitute for legal advice from a lawyer who will consider your specific needs.