Why are Holding Companies needed if you already have an incorporated operating company?

The answer to this question is not straightforward, both tax and commercial factors are relevant in each particular situation.  Several common reasons are discussed below:

Creditor Proofing and asset protection

It is not uncommon for many businesses to experience growth and accumulate excess cash or investment assets.  However, this asset accumulation in an operating company is not without risk of subject to claims from creditors.  One solution is to transfer those non-essential assets on a tax-free basis to a holding company and therefore provide a level of protection from creditors.

Purification for lifetime capital gains exemption

As mentioned from the “Why Incorporation of a Proprietorship” article that when shares of a corporation meet certain criteria, an individual resident in Canada may be able to shelter over $800k of capital gains from taxation from a share sale.   Should a corporation accumulate excess cash or other assets unused in the active business of the company, it might not meet the criteria  and would jeopardize this Lifetime capital gains exemption opportunity; however, if a holding company is introduced into the structure, it may be possible to transfer these “inactive” assets on a tax-free basis and maintain eligibility for the capital gains exemption. 

Flexibility for multi-shareholders or new line of business

It is common for companies with multiple shareholders.  Each of these shareholders are facing different tax considerations simply because they are not identical, and their ultimate remuneration structure could be varied significantly. A use of separate holding companies for each of these shareholders and adjusting the compensation structure to some form of dividend/salary mix may be possible to defer indefinitely a large portion of “unnecessary” personal tax liability – paying a tax free inter-company from the operating company the shareholders’ holding companies.

Also, it is common to use a separate company for new line of business to separate from rest of the existing operating company to provide further protection as well as flexibility for different combinations of investors/shareholders.

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email us for further advice.