A holding company is a company whose sole purpose is to hold shares in another company. It does not produce goods or perform services.
If a holding company owns a majority of shares in that company, it becomes the parent company.
The reasons for establishing holding companies are diverse;
They may be created to operate for a short period of time or as part of a long-term plan. Factors to consider include the nature and revenue of the business, the jurisdiction in which the business owner resides, and the business owner’s long term goals.
Advantages: Minimizing risks and exposure, a holding company can protect an owner’s interests by keeping creditors at a distance while removing cash from an exposed operating company to a holding company on a tax-free basis.
In this scenario, owners can take risks through the operating company while limiting the risk to that company and not exposing the holding company because the holding company performs no transactions and therefore does not move cash and other assets around. The holding company is exposed to risk to the extent of its investment in the operating company. So if a holding company lends money to the operating company, it can secure the debt and become a secured creditor (A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor) of the holding company giving the holding company priority when it is time for the debt to be repaid (especially in bankruptcy).
Tax Benefits: Corporate – Depending on the percentage of outstanding shares held by the holding company in the operating company, the dividends paid to the holding company may be tax-free. Individual – For shareholders with a high marginal tax rate, a portion of tax on dividends from taxable Canadian companies may be deferred until dividends are paid by the holding company to the shareholders. You may be able to locate the holding company in a province with a lower corporate tax rate.
Estate Planning: Holding Companies may help with succession planning by facilitating the transfer of wealth to the next generation. Shares in an operating company can be transferred to younger family members through a holding company by way of an estate freeze, structured to cap a person’s tax liability upon his or her death and transfer any future growth to family members.
Disadvantages: Set-up costs. Holding companies require additional set-up costs and these expenses can be ongoing, including the cost of preparing annual financial statements and corporate tax returns. If the number of shares is significant, then this is not so much of a concern.
No tax benefits or negative tax implications. As losses realized in a corporation are only available to offset other income earned by the corporation. Holding companies are also not eligible for the $750,000.00 capital gains deduction.
Double taxation may exist if personal tax is required to be paid as well as corporate taxes levied on the income earned by the holding company. To avoid the negative tax consequences associated with the payment of funds from a holding company to a shareholder, include the repayment of shareholder loans and taxable dividends (which may result in a refund of corporate tax to the holding company).
Director’s Liability: Many moons ago when I worked for the CRA, I came across many holding companies set up in order to protect directors from being responsible for unremitted source deductions, unremitted HST (PST and GST)corporate taxes and they also used passive directors – usually not involved in day-to-day operations of the business – but they are all still liabile for any debts incurred by the corporation. Passive directors should of course be aware of what the corporation is doing and should ensure that they are providing due diligence or have director’s liability insurance in place to protect them.