A holding company is a company that doesn’t have any operations, activities, or other active business. Instead it owns assets. These assets can be stocks in other corporations, units in limited partnerships, private equity funds, hedge funds, publicly traded stocks, bonds, real estate, patents, trademarks, copyrights, or virtually anything else that has value.
In many instances, a holding company (“Holdco”) is used to own shares of an operating company (“Opco”). In this capacity, Holdco can provide many benefits and flexible financial options to the underlying owners of the Opco. For example, presume Opco earns a profit annually. Each year Opco will pay taxes and keep the remaining profit in its retained earnings. Opco may also decide to pay dividends to its shareholder (i.e., Holdco). The following are several benefits in such circumstances:
- Tax-free dividend – Inter-corporate dividends (for the most part) are tax free. This means that the money sitting in Opco can be transferred by dividend to Holdco generally without tax consequences.
- Creditor protection – When we take the cash from Opco and put it in a place of safety with the Holdco, it has been virtually creditor proofed from creditors of Opco.
- Efficient Reinvestment – There is an immediate benefit to reinvesting some of Opco’s excess earnings in other assets to diversify holdings. This can be done by paying tax-free dividends from Opco to Holdco and then having Holdco make those other investments. If you paid the excess earnings from Opco directly to an individual, personally, to make those investments, the individual would pay tax first, leaving less to reinvest. By Holdco filtering out one layer of tax, the reinvestment of funds becomes tax efficient.
- Income Splitting – Income splitting through a Holdco comes in the form of nominally paying income to your wife and children (children have to be over 18) each year so that some of the earnings are taxed in their hands and not yours. The income can be in the form of salary or dividends. If your wife or children are not working or have low income, each may receive dividends of close to $50,000 (depends on the province) with minimal tax consequences.
- Loaning – Money dividended out to HoldCo may be loaned back to Opco and security taken creating additional creditor proofing and maintaining cash in Opco.
- Timing of Income – You can draw money out of Holdco whenever you want it.
Accordingly, there are many benefits and flexible financial options available when you incorporate a holding company.