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When to Consider Having a Holdco?


In a previous article, I discussed the benefits of incorporating. Specifically structuring one’s business affairs within an operating company (Opco). Generally, creditor protection, access to the capital gains exemption, access to low tax rates on active business income, and by default the benefits of tax deferral on profits not needed to support the lifestyle goals of the business owner(s) are the main reasons to do so. But why should one set up a holding company (Holdco)? When should one consider reorganizing their affairs to include a Holdco in the mix? In this article, I’ll explore these questions further and some additional items to consider.


A Holdco doesn't usually produce goods or services but simply is a place to “HOLD” assets, (including shares of an operating company (Opco)). For this reason, it’s sometimes referred to as a parent company. A holding company (Holdco) is a corporation generally found between the individual (or family trust) and an operating company (Opco). It’s also very common to find Holdco(s) as beneficiaries of a Family Trust. I’ll get to this one later. The shareholder (either individual or Family Trust) owns the shares of the Holdco which owns the shares of the Opco. In addition to holding the shares of Opco as a corporate shareholder, Holdco is mainly the place where passive assets (or surplus capital) that Opco generated over time are housed and managed. Usually, you’ll find that Holdco’s are introduced after the Opco has been in place for some time (during the growth or the maturity phase of the business cycle). The inclusion of a Holdco as part of a corporate restructuring process is mostly motivated by the ability of the business to generate surplus capital and/or by the need for succession planning involving the business owners' children (estate freeze) or the eventual sale of the business to an outsider.


The three main reasons why a Holdco is useful are:


  1. for a business owner(s) to protect their corporate assets from potential creditors of Opco and

  2. to allow a means for the business to manage business assets in a corporate group and position Opco for future sale.

  3. to provide autonomy over one’s share of corporate passive assets. It’s here where we sometimes hear the Holdco being referred to as an Investco. One in the same thing, really.

When contemplating the implementation of a Holdco structure, shareholders should consult with their legal and tax advisors to mitigate unwanted tax issues by considering the following items:


  • Being able to transfer their shares of Opco to Holdco on a tax-deferred basis and (section 85)

  • That Holdco and Opco are “connected” (defined below) to allow for surplus capital to flow tax-free from Opco to Holdco in the form of tax-free intercorporate dividends facilitated by sufficient safe income (section 55(2)), and

  • That the individual shareholder(s) either crystallize or preserve their ability to use their capital gains exemption.

The key advantage that a Holdco has in comparison to an individual shareholder is its ability to receive the funds without needing to make a taxable distribution from an Opco. Generally, a corporation can pay a tax-free intercorporate dividend to a corporate shareholder (i.e. Holdco) where the two corporations are “connected” for tax purposes. Establishing a “connection” can happen in 2 ways:


  1. Holdco owns more than 10% of the votes and values of Opco. OR,….

  2. Holdco controls Opco.

Control in this context means owning more than 50%. The person who controls Holdco also controls Opco. Also, Holdco is connected to Opco if the person who controls Holdco and owns part of Opco is related to the person or persons who control Opco. When this is satisfied, Opco may be able to pay tax-free intercorporate dividends to Holdco.


Another important technical point to address is that Holdco shares in Opco must have enough “safe income” attributed to them to be able to allow the funds to flow out as a tax-free intercorporate dividend. Section 55(2) of the Income Tax Act defines the mechanism in greater detail and what qualifies as safe income. I’ll explore this topic next month and why advisors should be aware of this.


Creditor Protection:


As discussed in a previous article, Opcos are used to protect the individual shareholder’s personal assets from business creditors. Holdco on the other hand is used to protect corporate assets from business creditors. These same corporate assets can either remain in the Holdco and be fully protected from Opco creditors or be loaned back to Opco for business purposes. This loan to Opco can be structured in such a way that Holdco takes a security interest over Opco assets, making Holdco a “secured creditor.


Manage business assets in a corporate group and position Opco for future sale:


In addition to creditor protection, a Holdco (or another Opco) can be useful to separate the hard assets (i.e. land, building, plant equipment) from the original Opco to position the original Opco for future sale. The shareholders may want to only sell the Opco and not the other hard assets. Here you’ll find the shareholder(s) of Holdco (or another Opco) are the same shareholder(s) as the original Opco. The only difference is that they house the hard assets in a separate corporation.


Autonomy over their share of passive assets (personal Holdco/Investco):


When an Opco holds and generates excess surplus capital, which is not needed for business purposes, and has multiple shareholders that hold different objectives with respect to risks, lifestyle, and tax and estate planning, having their own Holdco is key. An individually owned Holdco (not shared with other Opco shareholders) gives them the space and the place to set their own course as to how funds should be invested and consumed. One shareholder may consider purchasing permanent life insurance to be able to tax-efficiently transfer their wealth to their estate while the other may decide to consume all their assets in their lifetime. Polar opposite for sure, but drives home the importance of having a Holdco. In a more complex corporate structure involving a family trust, it’s common to find a Holdco(s) as a beneficiary of the trust.


By going through this process of “purification” which involves stripping Opco of these passive assets and ensuring that they fall below 10% of the value of Opco, the ability to use the capital gains exemption is preserved for a future sale or gift (deemed disposition). Sometimes the capital gains exemption can be “crystallized” (whereby the exemption amount gets added to the original ACB) while undergoing an estate freeze (re-org which usually involves a Holdco).


Other considerations:


Since the capital gains exemption is only available to individuals and not corporations, selling shares of an Opco that are solely owned by a Holdco disqualifies it from the capital gains exemption. Luckily, there are planning tools that involve the crystallization process mentioned in the previous paragraph that can be effective in preserving its use.


Most provincial associations (provincial governing bodies) that govern professionals (i.e. doctors, dentists, lawyers, accountants, etc.) have limits on the types of corporate structures their professional (licensed members) can have. For example, lawyers in Ontario who are incorporated can have the shares of their Professional Corporation owned by a Holdco but most other professionals including doctors, dentists, and accountants in Ontario cannot.


Transferring life insurance policies between Opco and Holdco can trigger various layers of taxation. I’ll explore this topic in more detail in a future article.


Since Holdco and Opco are considered associated corporations, the income it earns on its passive assets is included for the purposes of calculating the small business deduction limit (SBD). Once passive income (or adjusted aggregate investment income) exceeds $50K in a fiscal year the grind on the SBD limit for the subsequent year begins. Access to the SBD limit is reduced to zero once passive income exceeds $150k in a given year. To learn more about this topic, refer to a previous article from May 2023: Insurance Planning around the Passive income tax rule changes from 2018 (qfscanada.com)


There are costs involved when starting a Holdco. Having a lawyer help draft the documents of incorporation is a good idea but it’s not free. In addition to this, there are ongoing costs, such as annual legal filings, annual corporate tax returns, and potential bookkeeping costs prior to filing the corporate tax return.


As advisors, when exploring the suitability of various permanent insurance planning solutions with our business owner clients, such as the Corporate Estate Bond strategy, the Corporate Insured Retirement Plan, or the Immediate Financing Arrangement, we generally find that the funds required to support these solutions are housed in a Holdco setting. If they’re not, it would be prudent to suggest to the client to seek advice to consider a Holdco for this purpose. Although there are many advantages to including a Holdco, careful consideration must be given to all factors before proceeding. Aligning oneself with both a tax and legal professional who specializes in this area will go a long way to making an informed decision.



Tony Gallippi, B.A.S (Hons.) CFP CLU

Director, Advanced Planning, Insurance

QFS

tony.gallippi@qfscanada.com












This communication reflects the views of Qualified Financial Services Inc. as of the date published. The information in this publication is for general information purposes only and is not to be construed as providing individual legal, tax, financial or other professional advice. Qualified Financial Services Inc. assumes no responsibility for any errors or omissions in the information contained herein nor for any reliance placed on such information. Please seek independent professional advice before making any decisions.


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