Do You Require a Holding Company in Addition to Your Operating Company?
Business owners frequently ask . . .
Business owners often have a question of whether they require a holding company in addition to their operating company. The question is frequently asked when cash is being earned in an operating business that is more than what is needed to fund business operations and personal consumption.
The tax rules allow dividends (subject to various restrictions) to flow tax-free between companies in a connected group.
Retaining excess cash not required for business operations within the corporate structure makes sense due to the tax deferral of personal tax. This allows more dollars to be available for investment.
A holding company allows excess cash to be held corporately but outside the operating company.
There are three main reasons not to retain excess cash within a operating company:
- Maintaining access to the Small Business Capital Gains exemption available on the sale of shares of a operating company. The Small Business Capital Gains Exemption has various active asset tests, 90% on the date of sale and 50% for two years before the sale, having passive assets in the operating company can prevent the active asset test being met.
- If excess cash is retained in the operating company, the cash is exposed to the operating company’s creditors
- Removing non-target assets from the operating company in anticipation of sales can trigger a capital gain on the value removed; therefore, having the assets invested outside the operating company well before the sale is advisable.
Careful consideration should be given to whether active real estate should be held in a separate holding company to keep the value protected from the operating creditors. Doing this will allow for a sale price that can be more manageable for future business purchasers and provides the business owner with the flexibility to sell just the operating business while retaining the real estate ownership.
When setting up a holding company, this should be done in a way that does not compromise access to the Small Business Capital Gains exemption, which may require the use of a family trust.
If you want to discuss how a holding company can increase the tax efficiency of your overall financial plan, please contact me at rob@covenant.ca.
