Is a Holding Company Right for Your Client?

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Jamie Golombek, managing director of tax and estate planning with CIBC Financial Planning and Advice.

When we talk about the word holding company, there are really two concepts that come to mind. A holding company can be a company that doesn’t itself produce goods or services, but exists either to hold shares of another operating company or to hold investments. Sometimes, the holding company holds shares of another company that carries on an operating business, and the holding company is simply interposed between the business owner and the active business. And that allows profits to be flowed up and retained into the holding company.

The other use of a holding company is simply to hold a portfolio of either marketable securities or some rental properties rather than choosing to own those investments in your own name. So, a question people often ask is, “Why do we even have a holding company?” Or in fact, “Should I set up a holding company?” Let’s begin with discussing a holdco in the context of an operating company.

Why would you consider a holdco to own an operating company? Perhaps the biggest reason why business owners use a holding company is for asset protection. And what we effectively mean is that operating companies could have trouble. And the concern that we have is if a creditor of the operating company decides to sue that opco, it could have access, theoretically, to all of its assets. If we can regularly purify the operating company by moving excess cash or investments that we don’t need, the operations of the business up to a separate holding company, we can try to keep the operating company distinct. And therefore, should something happen ultimately later on, and then we are protecting certain assets in that particular situation.

There are other reasons why people might use a holdco. The other reason that we do for tax planning purposes is to have some flexibility in timing. And what a holdco can do effectively is it allows you to have the opco pay dividends up to the holdco, and that can be done on a tax-free basis, and that income can then be held inside that holdco until perhaps a later year when you, the business owner, actually need the money. You have more control over the timing of receiving that income personally when you are using the holdco. Because if you had an opco and that paid dividends on all of its shares, if you have different shareholders — some that need income this year, and some that wanted income next year — there is no way to prevent current income taxation when dividends are paid directly out of an operating company to an individual. By interposing a holding company between yourself and the operating company, you can actually have the dividends paid from the opco to the holdco tax deferred, and leave that money in there for future use.

There’s a variety of other reasons. For example, protection against U.S. estate tax, the use of a holdco in acquiring a corporation, or even in the future sale of a business. Sometimes it’s used in the context of an estate freeze. That’s the general rules and opportunities for a holdco when you own an operating company.

But the question that we get more often is what about incorporating my investment portfolio? Would it ever make sense for a holdco to simply be used to hold a marketable securities portfolio? In those cases I would say the answer is no. And the reason for that is because of the negative integration that we have for investment income in a holding company.

Indeed, in all provinces in Canada there was actually a tax cost from earning investment income inside of a private company as compared to earning that same investment income personally. That cost can range from as low as 2% in a territory like Nunavut, to something as high as nearly 8% in Nova Scotia. Capital gains would be at half that.

So, in other words, it doesn’t really make a lot of sense in most cases to incorporate a portfolio of marketable securities. However, if you already have investments or cash inside of a company because it used to perhaps run an operating company, or it has received dividends paid up from an operating company, then the cost to take that money out could be substantial, whether it’s paid out as an eligible or non-eligible dividend. In that case, it may make sense to keep the money inside of the holdco, even though there was a negative cost of integration, because the cost of taking the money out is so dear.

And then finally, there are other considerations that you want to think about — things like the small business deduction. New rules for 2019 say that if you have passive income more than $50,000, you could lose the federal and in most provinces, provincial, small business rate at a ratio of five to one. So, you have to also consider any investment in a holdco that you have could access the operating company’s ability, if they’re associated companies, to claim the small business rate.

For more information on anything that I’ve talked about today, please take a look at our most recent report called Hold the Holdco! Is a Holding Company Right for You?