A Holding Company is simply a Company that owns the shares of another Company (a subsidiary Company). Usually Holding Companies do not do any active business. The active business is done in the subsidiary Company.
Some common uses of a Holding Company include:
- A tax advantage in Canada exists in that intercorporate dividends between a subsidiary and its Holding Company are not subject to income tax in Canada. This allows the sheltering of after-tax earnings from exposure to lawsuits or other potential liabilities of the operations of the subsidiary Company. Most liability would be incurred by the operating Company, but most of the after-tax cash would end up in the Holding Company on tax-free intercorporate dividends.
- Acquisition of a Company or companies is less expensive in cases where the purchase price is funded by bank loans or self-financing with after-tax Company profits. Since inter-Company dividends are tax-free, the operating Company can pay after-tax dividends at low corporate tax rates to the Holding Company and the Holding Company does not have to pay additional corporate tax on the dividends. These dividends can then be used to repay the bank loan or to repay the shareholder for the original purchase.
- Estate planning purposes where the shareholder wants to involve family members in future growth of the subsidiary operating Company. Utilizing a Holding Company, the original shareholder “freezes” the value of the subsidiary Company by using complex provisions of the Income Tax Act. The result is that future growth in value of the subsidiary Company passes to family members and the family members may take advantage of the tax-free capital gains exemption.
- Corporate reorganization where unrelated parties own an operating Company but have differing views on how to spend the after-tax earnings. Each shareholder could reorganize to have a Holding Company which receives its proportionate share of inter-corporate dividends tax-free. Each shareholder can then decide how they want to spend the money in their Holding Company.
- Making a corporation attractive to a potential buyer. The operating Company can move redundant assets by way of tax-free intercorporate dividends to the Holding Company which makes the sale price of the operating Company lower. The purchaser would be more likely to purchase a Company which is less expensive but has the same earnings potential.
ROMANOVSKY & ASSOCIATES LLP
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