Business Consulting

When Can Small Business Owners Consider Setting Holding Companies?

October 5, 2023

An image of two small Toronto business owners meeting with their Markham CPA to discuss whether or not they should consider setting a Holding Company?

Small business owners think about growing their businesses and protecting their assets from heavy taxes and business risk. They work with business and tax consultants to devise strategies to reduce risk, and holding companies is one such popular strategy. The risk can be losing your assets to creditors, exposing your gains to heavy taxation, losing control of your business, or limiting business expansion. A holding company can come in handy and help you and your business in many ways. 

How Holding Companies Works? 

A holding company holds assets or controlling stakes in other operating companies, called subsidiaries. The holding company can own a 100% or a controlling stake in one or more subsidiaries. Every subsidiary has management that oversees the business operations, and the holding company’s management oversees the subsidiaries. However, the latter actively participates in major policy decisions like a merger or dissolution or appointment of a CEO. A holding company earns money through dividends subsidiaries pay to shareholders. 

The above is the structure of a pure holding company. You can make this structure complex with an intermediate holding company that holds other holding companies. Or you can have a holding company that owns a controlling stake in subsidiaries and also has its business operations. Such a company earns money from dividends and operations. 

In this article, we will look at ways small business owners can use a holding company.

Using Holding Companies To Manage Different Businesses 

As you expand your business and introduce different products and services, it becomes difficult to manage all operations. You can create a separate business for each service and control all the subsidiaries under one holding company. 

For instance, Peter owns an investment magazine under the name X Publications. He expanded the business to include an insurance magazine, a personal finance magazine, and a broking firm. He can open each of these businesses as a separate subsidiary and hold a controlling stake in each subsidiary in a holding company named X Holding.  

This way, you maintain a controlling stake in your business while allowing it to expand and branch out into other areas. 

Using Holding Companies To Protect Assets And Intellectual Property 

A holding company need not own companies only. It can also own intellectual property, equipment, real estate and investments. When you own assets under the name of a holding company, you protect them from credit and business risk. How will this structure work? 

Let’s continue with our above example. Peter’s business is doing well. He saves up all the dividends in the holding company and buys a building in the name of X Holding. Or he can create a separate operating company, “X Estate,” to own the building and hold a controlling stake in the company through the holding company. Now, he rents offices to each of his subsidiaries and collects rent from them under the name X Estate. 

Now, one day, his broking firm comes under a lawsuit as a technical error costs a client thousands of dollars. The court can use all assets of the broking firm towards the claim. However, the court can’t take the building as the broking firm does not own it. 

However, this protection layer will vanish if the corporate veil is breached and you get accused of fraud or negligence. In such a scenario, the authorities can cease all your assets having a link, including all your holding companies. 

Tax Planning 

Even with a single business, you can create a holding company for tax planning and deferral. Under the Canadian tax system, a company-to-company dividend transfer is tax-free. So, instead of withdrawing all your income and dividends from your business, you can transfer them to a holding company tax-free and withdraw them when you are in a lower tax bracket. 

For instance, Amy runs a media firm that makes local ads for small businesses. She is also an actress. She gets a project that pays her handsomely about $85,000 and puts her in a higher tax bracket. In the same year, her company declared a $25,000 dividend. She can transfer the dividend money to the holding company and withdraw it when her taxable income is low. 

You can even distribute dividend income to family and non-family members if they meaningfully contribute to the business. But talk to your tax consultant to ensure you are not breaching income-splitting rules. While your money is in the holding company, you can invest it in other securities. As corporates enjoy lower tax rates, the investment income will incur a lower tax rate. 

Using Holding Companies For Lifetime Capital Gains Exemption (LCGE)

A holding also comes in handy even when you plan to sell your business. The Canada Revenue Agency allows small business owners to claim a lifetime capital gains exemption ($971,190 in 2023). To qualify for this exemption, 

  • 90% of your company’s assets should be used for active business at the time of sale. 
  • 50% of your company’s assets should be used for active business 24 months before the sale. 
  • The owner must hold the shares for at least 24 months before the sale date. 

So if your business has been accumulating a lot of cash with no reinvestment in the business, you can transfer that into a holding company as dividends. Only keep 10% of cash and investments not used in active business. This way, you qualify for the long-term capital gain exemption (LCGE) while retaining your cash assets. 

If Amy sells her $1.2 million business for $2 million, she need not pay any long-term capital gain tax on the $800 million gain if she qualifies. Without the holding company, Amy would have to pay a capital gain tax of $400 million, which is 50% of the total gain. 

These are just a few uses of holding companies. You can use them in many ways and create complex business structures. But remember, it is expensive to manage a holding company. A professional business consultant can help you design a suitable holding structure. 

Contact KSSP Partner LLP in Markham for Tax And Business Structure Planning 

A skilled business consultant can help you determine the best business structure to protect your assets from heavy taxation and credit risk. At KSSP Partners LLP, our business consultants and tax experts can provide you with recommendations on storing wealth in structures best suited for your business. To learn more about how KSSP Partners LLP can provide you with business structure expertise, please contact us online or by telephone at 289-554-5997.