Why does anyone do estate planning? To protect their life savings from creditors without losing control of it, and protect the estate from significant tax liability while investing the savings to build wealth. Another major objective of estate planning is a smooth transition and/or succession of the estate to beneficiaries in a tax-efficient manner.
You have several estate planning instruments, such as a family trust, life insurance, and a holding company, and each of them serves a different purpose. Which instrument to use depends on the type of assets in your estate and what you want to achieve. Some complex estates use a mix of all three to achieve the desired outcome.
The Structure of a Holding Company?
For tax purposes, a holding company is treated as an incorporated company and enjoys the lower corporate tax rate. Like other companies, a holding company has to prepare financial statements and file corporate tax returns.
On the legal front, a holding company is a separate legal entity and enjoys tax-free transfer of intercorporate dividends. However, in the operations part, a holding company holds assets, such as cash, real estate, investments like stocks, mutual funds, gold, or shares in one or more operating companies. A holding company doesn’t sell goods and services but can hold shares of operating companies that sell goods and services. In such a scenario, the operating company becomes a subsidiary.
The holding company is the owner of the assets it holds, thereby protecting them from any potential claim from you or your company’s creditors. Like any company, it can invest those assets to build more wealth and get taxed on this income at the corporate tax rate.
Does Your Estate Need a Holding Company or a Trust?
The structure of a trust differs from that of a holding company in terms of control over assets and tax implications. While both structures hold the estate and protect it from creditors, their operating methods differ.
In a holding company, you maintain full control of the assets, determine when to withdraw cash, dividends, capital gains, and when to hold the assets in the company. If you retain the assets in the holding company and reinvest, you can invest higher after-tax income because of a lower corporate tax rate.
In a trust, the trustee manages the estate and distributes income to beneficiaries as specified in the trust document drafted by the estate owner. If the trust retains the income from the estate and reinvests it, the trust will be subject to the highest tax rate.
If your intention is to redistribute the income and benefit from the lower tax bracket of other family members, a trust is a good option. However, if you want to retain that income and withdraw it at a future date, a holding company is a good option. Before making any decision, consult a professional estate planner, as there are many other factors to consider.
What Assets Does Your Estate Have?
A holding company is better for complex assets such as real estate and shares in an operating company. Here’s why:
- Defer taxes: If your operating company is giving dividends, they are taxable in the hands of the shareholder at the personal income tax rate. However, you can transfer these dividends from the operating company to the holding company tax-free and use them to make investments. Until you withdraw, you need not pay personal income tax, thereby deferring taxes. You can schedule withdrawals depending on your total taxable income that year. If you retain dividends in a trust, they will be taxed at the highest rate.
- Seamless Transfer of Estate in Succession Planning: A holding company facilitates an estate freeze in succession planning. In this, the owner freezes the value of shares at the current price by converting them into preference shares. New common shares are issued to new shareholders, and any appreciation in the share price from that point forward is taxable to them when they sell their shares.
- Maintain Eligibility for Lifetime Capital Gains Exemption: If you are planning to sell your operating business, Canadian small business owners can avail themselves of a lifetime capital gains exemption (LCGE), which is above $1 million. There are some eligibility criteria, which, if you meet, can help you save tax on over $1 million in capital gain from the sale of a business.
These are basic considerations for creating a holding company structure. However, this structure can get complex, and a small mistake can increase your tax liability. Also, don’t forget that the accounting and legal costs associated with the holding company make it a good option only when the estate is substantial. The benefits should outweigh the cost of running a holding company.
Contact Black and Gill LLP in Etobicoke for Your Estate Planning Needs
A skilled estate planner and tax advisor can help you plan your estate in the most tax-efficient manner. At Black and Gill LLP, our tax advisory team can provide services to support your tax and estate planning function, whether you need partial or complete support. In addition, we can provide recommendations on how to store wealth in structures best suited for your business. To learn more about how Black and Gill LLP can provide you with the estate planning expertise, contact us online or call us at 416-477-7681.