If you’re currently incorporated, operate more than one type of business or farm, there may be important benefits to understanding a holding company (Holdco) model. Let’s consider a typical case where setting up a Holdco makes sense.
Husband and wife Richard and Sarah, farm together as an informal partnership, and are equal partners in their incorporated oilfield business. The oilfield business owns some of the farm land and machinery as it has more after-tax dollars available to spend than the farm has. The risk in this arrangement is the exposure of both businesses to cross liability from the other business. For example, a tire blows out while hauling silage on the highway, the truck veers across the road and wipes out a mini-van and the family in it. Not only is the farm liable, but the oil field company as well.
Conversely, an industrial accident that their oilfield company was responsible for, would also put them personally and their farmland at risk.
A solution would be to set up a Holdco to own the shares of the oilfield company, then transfer ownership of the farm land and machinery to the farm. Setting up a farming company would minimize the cross liability risks they currently face. Another benefit is, they could move the building and operational assets currently owned by the oilfield company up to the Holdco. Later if they sold the business, they could keep the building and fixtures and get paid a rental stream to enhance their retirement income.
There are a number of benefits of Holdcos:
- Tax-free dividends. Dividends paid by an operating subsidiary (Opco) to the parent holding company (Holdco) are generally tax-free.
- Creditor protection. Excess earnings in the Opco can be paid to the Holdco as a tax-free dividend, protecting those earnings from creditors of the Opco. And if needed, it can be lent back to the Opco on a secured basis and continue the protection from creditors.
- Efficient reinvestment. By way of tax-free dividends from the Opco to the Holdco, the Holdco can reinvest some of the Opco’s excess earnings in other assets to diversify their holdings.
- Income splitting. An owner is able to pay income to his wife and children each year so that some of the earnings are taxed in their hands rather than his. Their income can be in the form of salary if they are doing work of some kind, or as dividends.
- Timing income. A Holdco can act as a private pension source, as the owners can draw money out of it when they need to. They can also choose to pay themselves dividends every other year, allowing them to avoid quarterly tax instalments. This is because it’s possible to base instalments on either the previous year’s tax owing, or the current year’s expected tax liability. If one has little or no tax liability every second year, they can base instalments annually on the year they expect to have little income.
- Avoiding U.S. estate tax. Canadian residents can be subject to U.S. estate tax if they own U.S. situs property such as shares in U.S. corporations, among other things. Because companies don’t die, you can sidestep the U.S. estate tax by holding these investments in a Canadian Holdco
A Holdco will add complexity and costs, so it’s important to sit down with a trusted tax professional to talk about all the pros and cons before making the move to this type of structure.
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