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Holding Companies Demystified: Strategies for Profit and Protection | Antonio DiMinno

Overview

Toronto business lawyer, Antonio DiMinno, of DiMinno Rizzi Lawyers, provides a basic overview of holding companies.

The term “holding company” is widely familiar among entrepreneurs and has gained almost a mythical status among Toronto business owners. But most entrepreneurs don’t really get what a holding company is, and they often use the term the wrong way.

So, let’s try to understand it better and clear up the confusion.

What is an Operating Company in Canada?

An operating company is the actual active business that deals or “operates” in the outside world. Most companies that exist are operating companies, from your local grocery store or restaurant down the street to many large companies you may see on TV.

What is a Holding Company in Canada?

A holding company is a special type of company that exists mainly to own the shares of one or more operating companies (also known as “subsidiaries”). A holding company may also hold investments, such as shares in public companies, real estate, or GICs.

Why Create a Holding Company?

To understand why you would create a holding company, it is best to start with an example.

You are a business – any kind of business. You could be a construction company, a realtor, an accounting firm, or an electrical contractor.

You start your business so you can earn a living. As your business grows, you start doing two things.

First, you start to accumulate “assets” – things that are worth money and, hopefully, make your business better. This can be inventory, equipment, intellectual property, lead lists, online funnels, code, property, etc.

Second, as your business grows, you also accumulate more liabilities. This happens because you need more space, employees, and advanced technology and equipment to support your expanding operations.

Both factors, assets, and liabilities, make you more visible and vulnerable to potential legal issues. As your business prospers and you do and acquire more,  the likelihood of facing lawsuits increases. In fact, at a certain size it is only a matter of time before you face a lawsuit or dispute. These can include, among others:

  • Contracts with other businesses and suppliers
  • Real estate leases
  • Contracts with employees
  • Slip & falls on your company premises 
  • Claims of faulty or poor worksmanship
  • Disputes/lawsuits with competitors
  • Disputes/lawsuits with public authorities, like the city or province
  • Taxes

As your operating company handles the day-to-day operations of your business, it becomes the most vulnerable to potential disputes and legal issues. At the same time, you are retaining your profits in your business, and you’ve accumulated a pool of profits that are sitting in the company, ready to be deployed for the business, to expand, and to invest.

This means that your profit pool is incredibly vulnerable if your operating company gets into trouble. Creating a holding company solves this problem.

Any profits held in the company can be drawn out and up into the holding company, tax free. That way, if you operating company ever gets sued, a creditor cannot attack your profits because they are in another entity (the holding company).

What are the Advantages of a Holding Company?

#1: Creditor Proofing

See above.

 

#2: Tax Savings

Another great benefit of a holding company is that it is a powerful tool to minimize taxes.

Imagine you have a business that makes a lot of money. But you don’t need all that money to run the business and cover your living expenses. If you keep all the extra money in the business, you’ll have to pay a lot of taxes on it.

So, there’s a smart trick you can use called a “Holding Corporation.” It’s like having a separate safe box for your extra money. When you put the extra money into this safe box, you don’t have to pay as much tax on it.

Here’s how it works: Let’s say your business makes $200,000, but you only need $50,000 for your living expenses. If you put the extra $150,000 into the Holding Corporation, it won’t get taxed right away. You can keep it there until you need it, and then take it out without paying extra taxes.

By using the Holding Corporation, you can control how much money you take out and when you take it out. This way, you can be smart about taxes and keep more of your hard-earned money.

This strategy, often referred to as a “cash sweep”, is like having a special savings box for your business profits that you can deploy when you want while minimizing tax.

 

#3: Capital Gains Taxes

The lifetime capital gains exemption (LCGE) is a special tax rule that helps you save up to $971,190 in taxes when you sell your business.

But to get this benefit, you have to meet certain rules and conditions. And using a holding company structure can make it easier to qualify for the LCGE. 

This can get a little complicated, so it’s best to speak to your tax professional to learn more.

 

#4: Wealth Planning and Investing

The holding corporation is a great way for business owners to invest their profits. It’s like a special box where you can put your extra money to make it grow even faster.

When you move the money to this special box using something called “inter-corporate dividends,” you get to keep all of it to invest. This means you can make your money work harder for you, and invest with pre-tax income. 

This is much better than if you took the money out personally and had to pay half of it in taxes. With the holding corporation, you can grow your money faster and have more to invest, which helps you make even more money over time. It’s like a supercharged way to grow your wealth and make your money work smarter for you!

 

What are the Disadvantages of a Holding Company?

Administrative Costs

Like any legal structuring, there are costs to creating and maintaining a holding company. The first of these is having a lawyer incorporate the Holdco. This step is crucial as it establishes the founding directors, initial share structure, and rules governing the corporation.

There are also ongoing costs. Annual legal return filings are necessary for the Holdco to stay in good standing with the governing body of its incorporation (see: Minute Book). Moreover, the holding company must file a corporate tax return each year, meeting the CRA’s requirements, and file a T5 information return when distributing dividends to optimize taxation. In addition, proper bookkeeping is essential for managing assets and investments and ensuring compliance with tax regulations.

 

Administrative Management

Running a holding company comes with its own set of challenges, especially when it comes to legal and tax filings. It’s crucial to plan carefully to avoid any negative tax consequences. If you’re not familiar with these matters, it’s essential to find someone reliable to handle them for you. Keeping track of your assets and understanding the tax implications is vital to prevent potential disasters and owing large sums of money to the government.

How a Toronto Business Lawyer Can Help

When considering creating a holding company, a crucial first step is to speak to a holding company lawyer.

If not incorporated and managed properly, a holding company can actually cost you MORE in taxes. So, finding a knowledgeable business lawyer and business accountant is absolutely critical. A good business lawyer will work closely with you to clear the fog and ensure that your company is sailing in the right direction!

 

Antonio DiMinno

647-205-9128

antonio@drlawyers.ca

Contact us today for a free strategy session!

 

Disclaimer: All number figures are approximate only and may be subject to change. Like all material on this website, this is not financial, legal, or tax advice. Contact a professional for your specific situation. 

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