You may have heard it from your brother or your neighbor or your friend and you may be wondering, “What the heck are they talking about?”, and “Are they right?”. I will try to address the basics and you can make your determination if you want to get advice from a tax professional or “George, the local butcher”. This blog is by no means comprehensive or meant to replace advice from your accountant, but more of a way to get get the brain rolling in the right direction! There are a plethora of ways to set up the structures, so please consult with an expert who can guide you through the process for the best scenario to meet your particular situation.
Most of the Canadian small business corporations that you and I deal with in our everyday lives are what you would call an “Operating Company” (Opco). You may even be the owner/shareholder of one yourself and if it carries on in active business, then there may be a way for you to defer tax by setting up a “Holding Company<https:/en.wikipedia.org/wiki/Holding_company>” (Holdco). If your Holdco owns shares of your Opco, in most cases you may be able to pay a dividend to your Holdco. Under ITA 112(1) , your Holdco may be able to claim a deduction for those dividends to avoid Part Four tax. By passing the earnings to your Holdco, you are deferring tax until you take it out of the company one day through varying means.
Multiple shareholders: Setting up a personal Holdco for each shareholder can provide great flexibility. Dividends can be paid out to each of the Holdcos on a tax free basis and each shareholder can control the flow of dividends out to the shareholders of their own personal Holdcos as their needs and plans require.
Splitting income: You can sprinkle dividends to the shareholders of the Holdco, such as a spouse or other family member so that the tax burden on those dividends can be shared. It’s not always advisable to issue shares in the holding company directly to your children (and if they’re minors, this isn’t possible), and so a family trust can be utilized.
Establish a trust: The shares of your Holdco can be held by a family trust. The beneficiaries of the trust could include you, your spouse, your children and your holding company (among others). Dividends paid by your Opco to the trust can be distributed out to your Holdco as a beneficiary of the trust, and you’ll achieve the same tax-free payment to the holding company as you would achieve if the holding company owned the shares in the connected Opco directly ” The advantages, however, include: The ability to sprinkle dividends to family members or the holding company as beneficiaries of the trust, at your discretion; the ability to multiply the lifetime capital gains exemption on a sale of the shares of your Opco (assuming the shares qualify for the exemption); creditor protection over the property of the trust, including the shares of the Opco, among other benefits.
Protection from creditors: Any excess profits of your Opco can be paid to your holding company as dividends, which can then be lent back to your Opco on a secured basis thereby offering some protection from creditors of the Opco.
Retirement nest egg: The accumulation of assets inside your Holdco can become the type of retirement nest egg or “pension” that you will need to look after yourself in retirement. One of those assets may include a corporate participating life insurance policy…..but that topic is for another blog!
What I am trying to get across here is that there are many ways that these tax vehicles can be set up to offer maximum advantage for the taxpayer. This is certainly not a “one size fits all” issue and it needs to be very carefully weighed and thought out before moving forward. There are many costs involved too, not just in the initial setup, but in the annual maintenance and filing requirements of the entity. As with anything in life, the benefits will need to outweigh the costs if it is to be considered. This can open up doors for some exciting planning and to possibly keep some more “green” in your family!