5 Common Uses of A Holding Company

A Holding Company is simply a company that owns the shares of another company (a subsidiary company). Usually Holding Companies do not do any active business. The active business is done in the subsidiary company.

A tax advantage in Canada exists in that  intercorporate dividends between a subsidiary and its holding company are not subject to income tax in Canada. Another tax advantage in Canada is that each individual shareholder can potentially shelter $500,000 of capital gains on the sale of certain corporate shares. The following 5 Uses exploits these tax advantages:

1. Acquisition of a company or companies is less expensive in cases where the purchase price is funded by bank loans or self-financing with after-tax company profits. Since intercompany dividends are tax-free, the operating company can pay after-tax dividends at low corporate tax rates to the holding company and the holding company does not have to pay additional corporate tax on the dividends. These dividends can then be used to repay the bank loan or to repay the shareholder for the original purchase.

2. Estate planning purposes where the shareholder wants to involve family members in future growth of the subsidiary operating company. Through the use of a Holding Company, the original shareholder "freezes" the value of the subsidiary company by using complex provisions of the Income Tax Act which involves the use of a personal Holding Company. The result is that future growth in value of the subsidiary company passes to family members and a multiplication of the $500,000 capital gains exemption (each shareholder can access $500,000 capital gains tax-free) on the eventual sale of the company shares.

3. Corporate reorganization where unrelated parties own an operating company, but have differing views on how to spend the after-tax earnings. Each shareholder could have a holding company which receives its proportionate share of inter-corporate dividends tax-free. Each shareholder can then decide how they want to spend the money in their holding company.

4. Making a corporation attractive to a potential buyer. The operating company can move redundant assets by way of tax-free intercorporate dividends to the holding company which makes the sale price of the operating company lower. The purchaser would be more likely to purchase a company which is less expensive but has the same earnings potential.

5. Shelter after-tax earnings from exposure to lawsuits or other potential liabilities. Most liability would be incurred by the operating company, but most of the after-tax cash would end up in the holding company on tax-free intercorporate dividends which is potentially sheltered from the operating company’s liabilities. 

Caution is warranted and proper planning with your chartered accountant is essential. There are many pitfalls to the strategies discussed. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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