Can a Holding Company Structure Benefit Your Business?
When your business achieves a certain level of growth or complexity in its operations, you may wish to consider a holding company structure. This article will explore some of these advantages which include asset protection, estate and succession planning, and tax benefits. It should be noted at the outset that the decision to set up a holding company must be evaluated on a case-by-case basis with the assistance of a company’s legal, financial and accounting advisors.
Holding companies do not produce goods and services. Generally, the purpose of a holding company is to own shares in another company. Typically, a holding company will own all of the shares of the operating company or companies, as the case may be. However, other combinations of ownership may exist within various holding company structures, such as when holding companies hold real estate or other financial assets.
One of the main advantages of a holding company structure is asset protection which can be illustrated through the following scenario. Let us assume that an operating company faces insolvency or is involved in a lawsuit that could potentially bankrupt the business. If the operating company had previously separated its assets to a holding company, those assets, including the operating company’s accumulated corporate profits (or “retained earnings”) transferred to the holding company, would typically be beyond the reach of creditors and litigators who could otherwise attempt to seize such assets.
Furthermore, a holding company can loan funds to the operating company and become a secured creditor, which may allow the holding company to potentially have priority over other lenders if the operating company is unable to meet all of its debt obligations.
Similarly, in certain cases, a holding company holding real estate and other assets such as equipment and machinery may lease those assets back to an operating company, thereby protecting those assets from potential creditors.
Estate and Succession Planning
A holding company structure can assist business owners to efficiently transfer the accumulated wealth derived from their operating companies to their family members and the next generation. Estate and succession planning goals may be achieved by having shares in the operating company transferred to other family members through a holding company structure, which is commonly known as an “estate freeze”. Such a strategy not only transfers the future growth of the value of the shares to the family members and freezes the amounts of capital gains tax when the business owner’s shares are sold, but it also prevents these family members having to pay estate tax upon the death of the business owner since these family members will already own shares in the holding company.
One significant tax advantage of a holding company is that the operating company may issue dividends to the holding company on a tax-free basis, subject to various tax rules. This allows the holding company to defer issuing dividends to its shareholders thereby deferring tax until such dividends are issued. This is beneficial to shareholders who may presently be subject to a high marginal tax rate.
Additionally, with a holding company structure, tax efficient methods exist that allow for the distribution of profits of the operating company to others, such as a spouse, children or other family members, who may be in a lower tax bracket depending on their own financial situation, thereby reducing the overall tax paid on those profits.
Moreover, it should also be noted that it may be possible to set up a holding company in a province or jurisdiction with a lower corporate tax rate.
While a holding company structure provides some noteworthy advantages in connection with asset protection, estate and succession planning, and tax benefits as described above, individuals should obtain qualified legal, financial and accounting advice before establishing this type of corporate structure.
This article was written by Jindra Rajwans, a business lawyer based in Toronto, Canada. The information in this article is not intended to be legal advice and is of a general nature. Consult a lawyer for advice for any specific situation.