- August 3, 2020
- Posted by: pts123
- Category: Finance & Accounting
How Holding Companies are Advantageous to Small Business Owners:
In Canada, as other places in the world, the smaller businesses have a low survival rate, more specifically small businesses and medium sized businesses. Industry Canada claims only 51 percent of these sized business are able to survive and last longer than five years. Efficient planning from a tax perspective, by using holding companies, is one of the factors that attribute to the successful endurance and survival of these businesses.
What is a holding company or Holdco? Basically a Holdco is the company that owns the operating company. It is also used as a vehicle to minimize taxation with thorough tax planning. Some of the potential benefits to a Holdco include creditor protection, tax efficiency,succession or estate planning and income splitting. The operating company carries on with its normal day-to-day active business, which results in earnings. The earnings are paid out as dividends to the shareholders of the operating company. The shares of the operating company are owned by the Holding company , and as shareholder the Holdco receives the dividends from the earnings of the operating company. These funds are then used by the Holdco to safely secure the funds, or to reduce risks by diversifying investments.
One of the benefits to a Holdco is tax efficiency. This advantage is demonstrated by using the example of an owner of a business with a significant portion of net income.An inter-corporation dividend transfer is a method that can be used to move earnings, tax free, from the operating company to the Holding Company . The passive income of it’s assets will be taxed according to the relevant rate, but the individual is not taxed until distribution. The owner of the business wants to keep the small business status when the operating company becomes successful. To do this, the business owner needs to take the retained earnings, which has now become excess funds, out of the operating company. The reason being, that of the assets, minimum ninety percent are used in earning active business income. Therefore, he takes out the retained earnings by transferring these funds to it. In the event that the operating company requires funds at a later stage, the Holdco loans the secured funds to the operating company.
Another advantage is that it is used for the purpose of deferring tax. For example, XYZ is a small business, situated in Quebec. The income XYZ earns is $500,000, the maximum allowed to keep the reduced rate of “small business deduction”. This active business income will be taxed at the rate of 19%, for both provincial and federal levels, which is equal to $95,000. The amount that remains is $405,000, and these funds are transferred to Holdco to be invested. If the business owner, as an individual,receives these funds as bonus, the money will attract a tax of minimum 50%, which is far greater than the 19%.The amount of $250,000) that becomes available to invest, after tax, is much less than $405,000.
Another benefit is creditor protection. This means creditors cannot access the funds so easily. By transferring the earnings to a Holding Company, these funds have now been transferred to another separate entity that creditors do not have access to. When the funds are moved back into the operating company from it, the funds have secured status which grants protection to a certain degree.
A Holdco is a beneficial tool when used for succession or estate planning. The possibility of double taxation can be avoided by transferring assets to the heirs by way of trusts. Alternatively, at death the assets are liquidated. Spreading the income among the family members is another possibility. When a member of the family is employed by the company, or does works for them, income is received by paying out dividends or with a salary. This becomes advantageous when family members, are taxed in a lower bracket. However, attribution rules need to be considered.
Certain circumstances deem it possible to freeze an estate. This is another benefit . This allows taxes to be saved through postponement, and the heirs benefit from the company’s future growth. The amount of tax to be paid at death can be significantly reduced. It all depends on how soon the estate is frozen.
There are a number of factors to consider when establishing a Holdco. However a holding company is not always the right choice businesses. Despite the benefits, a business owner should not attempt in using and benefiting from it without adequate knowledge and sufficient deliberation.
This article only provides information in a general nature and is only as current as the date in which it is posted. It is not updated and therefore may no longer be current. This document should not be relied upon as it does not claim to, nor provide advice on legal or tax matters. All tax situations are specific in nature and will likely differ from the situations that are presented in the article. It is advisable that you seek and consult a tax professional if you have any specific legal or tax questions. This document is intended to provide general information on a particular subject or subjects(s) and this article is not an exhaustive treatment of such subject(s). In accordance, the information in this document is not intended to constitute or replace accounting, tax, legal, investment, consulting, or other professional advice or services. Before any decision is made, or any action taken which might affect your personal finances or business, you should consult a qualified, professional adviser.