Once many businesses get to a certain size, some owners start wondering if it\u2019s time to create a holding company \u2014 and whether that\u2019s worth the headache. The advantages must be weighed against the time and expenses associated with setting up and running another company. But in certain situations \u2014 typically, those in which an active business has accumulated considerable profits \u2014 the benefits of a holding company can justify the costs.
One of the best reasons for creating a holding company, which merely holds assets and does not carry on the entrepreneur\u2019s main activities, is to shield wealth from creditors and other litigants. Claims that arise as a result of the owner\u2019s business activities \u2014 such as unpaid debts or defective products \u2014 would be limited to the assets of the operating company.
Tannis Dawson, a chartered accountant and specialist in tax and estate planning for Investors Group Inc. <\/b> in Winnipeg, says many business owners leave profits inside their corporations \u2014 in effect, treating their businesses as if they were also their RRSPs.
Apart from the personal tax breaks these clients may be missing out on as a result of not using properly structured registered plans, RRSPs are another way to protect long-term savings from creditors in the event of insolvency or a large judgment against the operating company. Only amounts contributed to an RRSP within 12 months of bankruptcy are available to creditors.
One reason business owners tend to pile up cash in their operating companies is a common desire to support and nurture their companies, which may represent their life\u2019s work.
The downside is that these amounts can add up to substantial sums that are left virtually unprotected.
Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce<\/b>\u2019s private wealth-management division in Toronto, warns that the results could be devastating for some business owners in the event of an insolvency or other dramatic loss or expense that must be borne by the operating company. Moving the profits to a safe haven can avoid this result.
LIABLE TO CREDITORS<\/b>
\u201cIf the operating company gets sued and there are no assets, the [operating] company could go broke,\u201d he says. \u201cIf [the client\u2019s] whole life savings are in the operating company, and it gets sued and they don\u2019t have a holding company, all the money they\u2019ve accumulated there is potentially liable to creditors.\u201d
The holding-company strategy won\u2019t work at the last minute, though, notes Brian Doell, portfolio manager and director of Bank of Nova Scotia<\/b>\u2019s private-client group in Calgary: \u201cIf you knew a lawsuit was coming and you then transferred a bunch of assets over, they would probably go after those assets if they had a good forensic accountant working on it.\u201d
Such a manoeuvre might also leave the business owner open to allegations that the transfers were made with the intention of fraudulently trying to defeat creditors.
From a tax point of view, however, the pros and cons of holding companies are not quite as clear. Golombek says that in today\u2019s tax environment, it generally doesn\u2019t make sense to set up a holding company primarily to handle investments. While the dividends that are paid by the operating company to the holding company are not taxed, investments held in a corporation are generally subject to higher tax rates than is income from an active business. The operating company may be eligible for a range of special tax provisions designed to promote and support the growth of active businesses. There are also tax breaks that may not be available when the shares of holding companies are sold, such as the lifetime capital gains exemption, which currently is $750,000.
\u201cIn all provinces, there is a slight disadvantage to earning investment income in a corporation vs earning it personally,\u201d Golombek says. \u201cTax rates are very favourable for active business income but not favourable for investment income.\u201d
On the other hand, creating a holding company may allow a business owner to defer personal taxes by allowing greater control over the timing of the payment of dividends from the holding company to the controlling shareholder \u2014 typically, the business owner.
There are other pluses on the personal and family side. Paul Edmond, president of Winnipeg-based Edmond Financial Group, <\/b> says setting up a holding company can make sense from an estate-planning point of view. For example, if a father wants to pass his business on to his son, he could do an estate freeze through his holding company. This arrangement allows the father essentially to freeze the current value of the business and have all future growth accrue in the hands of his son.
@page_break@This is accomplished by issuing new preferred shares to the father, thereby keeping control of the company in his hands. Future growth (with accompanying liability for any capital gains taxes) is shifted to the son by giving him the common shares. Says Edmond: \u201cIt\u2019s another way of shifting the tax burden to the next generation.\u201d
OFFERS FLEXIBILITY<\/b>
Further flexibility arises out of the power to locate the holding company in the jurisdiction with the most favourable tax regime, an option often unavailable to operating companies. \u201cJust because you\u2019re living in Manitoba doesn\u2019t mean you have to set up a [holding company] in Manitoba,\u201d Edmond says, noting there are no residency requirements for holding companies.
Further, a range of assets can be held by the holding company, such as the real estate where the operating company is located. The strategy also allows the business owner to separate assets when the business is sold. If your client wants to sell an operating company, for example, that doesn\u2019t mean he or she necessarily wants to sell the bricks and mortar, Edmond says: \u201cA lot of people keep the holding company but sell the operating company.\u201d
Setting up the holding company can be a pain, however. Doell says creating a holding company can be \u201cpretty complex\u201d from a tax standpoint, which is why he recommends having an accountant help your client in setting up the structures and assessing the costs. There are also recurring needs to deal with, such as the requirement for a yearly tax return.
\u201cI typically wouldn\u2019t recommend [this strategy] for a small-business owner, but I would for the really affluent clients,\u201d Doell says. \u201cIt can become more of a benefit for estate purposes.\u201d
Doell adds that there can be income-splitting benefits from using a holding company, too, but they are dependent on the province and the unique personal situations.
So, once your client has his or her holding company ready to roll, how does he or she allocate assets in it? One strategy, Doell says, is to put fixed-income investments, on which your client would pay the highest taxes, into the personal registered plan and put equities in a non-registered account held by the holding company.
Doell warns that only disciplined investors will stick with such a strategy: \u201cThe danger is that when equities are doing well, the client won\u2019t like their RRSP account because it\u2019s lagging. When equities are crashing, they won\u2019t like their non-registered account. If the client is not committed to the strategy, there\u2019s a danger of making an emotional decision and switching the asset mix in one of the accounts when it\u2019s the worst time to do so.\u201d
Golombek also notes that a business owner can\u2019t hold an RRSP, RRIF or a tax-free savings account through a holding company because these are all considered personal accounts.
\u201cWe tell them they should sit down with [a financial] advisor or accountant to crunch the numbers,\u201d he says, \u201cto determine if it makes sense to pay money out of the holding company to themselves and pay personal taxes on that money, and then contribute to an RRSP, tax-free savings account or even a registered education savings plan or a registered disability savings plan. It\u2019s quite a complex issue.\u201d\tIE<\/b>
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