What is a Holding Company? And When Do You Need One:
What is a holding company? it is the opposite of a shell company (which holds no assets inside of it) in that it holds your precious assets.
A holding company is typically a Parent Company and not a Subsidiary Company. So typical structure is you would have your Holding Company which holds the shares of your Operating Corporation. It can also hold other stocks, bonds, and investments that you do not wish to hold personally for liability and tax reasons.
It is important to layer in a holding corporation to your operating business at the time when the business has attained significant profits. When your corporation becomes significantly profitable it is not efficient to allow asset accumulation inside your operating company.
For one thing that could disqualify you when you want to sell the company for the Lifetime-Capital Gains Exemption on the sale of the shares. because:
The assets held must meet this requirement:
all or most (90% or more) of the fair market value of its assets must be used in the business producing ABI (Active Business Income) and "Active" is the key word.
If your corporation has many assets such as surplus cash invested in investments (and your business is not an investment company by nature), then this is considered "Passive Income" to the corporation and if your assets held in investments is greater than 10%- it will not qualify.
Therefore purifying the corporation through a "Butterfly Reorganization" (which is beyond the scope of this article) is very important this is where the operating company divests these assets to you holding corporation known as "Purification" (and you thought that was just a Buddhist thing).
Two benefits of a holding corporation:
Creditor Proofing - this is where we do a "cash sweep" of your operating company - where you take all of the retained earnings profit pool of your operating company and it is brought up and out to the holding corporation (the parent co-) where it is now safe from creditors (however if there is a law suit or you are trying to evade nefarious action- then this can thwart your actions. So this is why it is done on a yearly basis). You want to do this year over year. You want to sweep profits only above your "Working Capital" needs of the corporation (its bare minimum to operate yearly). The nest egg is swept up to a safe entity to a holding corporation. A operating company is precarious to its creditors (covenant restrictions may limit), suppliers, employees, anyone it contracts with. For example- a wrongful termination suit could be filed anytime. Even general liability insurance may have waivers jeopardizing collection on the policy. So profits are transferred from the operating company to the holding company. This is done through Annual Inter-Corporate Dividends which are tax free to the recipient holding corporation.
Tax Advantages - Due to the high personal tax rate, its not always efficient to declare a dividend to a personal shareholder. Instead declare via inter-corporate dividends to your holding corporation instead which attracts no tax. The corporation pays much lower tax because of the Small Business Deduction than a shareholder would pay personally. The average marginal tax rate combined in Canada at the personal level is about 38%, where as average corporate tax subject to the small business deduction is approximately 12% and 26.5% for income excess SBD limit. Therefore corporation retains more money to advance its plans on world domination.