Business Owners: Why you MUST have a Holding Company (Holdco)

Today, I would like to share an excellent article written by Tim Cesnick, clearly explaining the advantages of Holding Companies.  At HazloLaw, we advise clients on a daily basis about the necessity of putting in place this type of structure and we also suggest to add a Family Trust to your current structure.  Please email us at info@hazlolaw.com is you have any questions.
HOLDING COMPANY
This summer when you're standing around the barbecue with your business-owner neighbours, impress them with your knowledge of tax planning.

I can tell you from experience that you'll bore them to tears with the conversation, but they'll thank you later when the tax savings start rolling in. Specifically, share with them that holding companies can help them to defer tax. Here are the highlights.

THE RULES

If you happen to own a corporation that carries on an active business, give some thought to setting up your affairs to allow for a deferral of tax.

How? By establishing a holding company to own the shares of your active business corporation (ABC).

You see, if you own the shares of your ABC directly, then any payment of dividends from that corporation to you will be taxable in your hands personally in the year you receive those dividends.

If, on the other hand, you have a personal holding company that owns your shares in your ABC, you can pay a dividend to your holding company that will, in most cases, be tax free to your holding company.

It's subsection 112(1) of our tax law that allows, in most cases, your holding company to claim a deduction for taxable dividends received from your ABC. And, as long as your holding company and ABC are "connected" under our tax law (which will be the case in the vast majority of situations), you'll avoid another tax called the Part Four tax.

By passing some of those earnings from your ABC to your holding company, you'll defer tax, which is essentially the difference between the tax paid by your ABC on its profits, and the amount of tax you would have paid had the profits been paid out immediately to you as a bonus.

The tax deferred is approximately 30 per cent of the taxable income in most provinces for someone in the highest tax bracket.

THE STRATEGIES

What strategies should you be thinking about?

Multiple shareholders: If you're one of multiple shareholders in your ABC, setting up a personal holding company for each shareholder can provide flexibility to each of you.

Think of each holding company as a tap to control the payment of dividends to each of you personally.

Your ABC can pay dividends to each of the holding companies on a tax-free basis, and then each holding company can pay dividends to its shareholders based on his or her personal cash requirements.

Splitting income: Your holding company can be owned by more than one person in the family.

Your spouse, for example, could own some shares. This will allow you to sprinkle dividends to your spouse or others in the family 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, which brings me to the next strategy.

Establish a trust: I really like this structure. The shares of your ABC can be held by a family trust.

The beneficiaries of the trust will include you, your spouse, your children (regardless of their age), and your holding company.

Now, any dividends paid by your ABC to the trust can be distributed out to your holding company 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 ABC directly, provided the two companies are "connected."

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 ABC (assuming the shares qualify for the exemption); creditor protection over the property of the trust, including the shares of the ABC, among other benefits.

Protection from creditors: Any excess profits of your ABC can be paid to your holding company as dividends, and can be lent back to your operating business on a secured basis, if the cash is needed for the business. This will protect those excess profits from other creditors of the business.

Retirement nest egg: The accumulation of assets inside your holding company can become the type of retirement nest egg or "pension" that you will need to look after yourself during retirement.

Top 10 ways to reduce your tax bill

Did you know?

There are a number of ways to reduce the amount of tax you owe and keep more money in your pocket at tax time. The Canada Revenue Agency (CRA) website can help you learn more about the various credits and deductions that you may be entitled to and that can save you money when you file your 2011 income tax and benefit return.

Important facts

For individuals:

1. Plan ahead - Go on CRA's website and Register for My Account, gather your receipts and NETFILE access code, and sign up for direct deposit before April 30. Submitting your income tax and benefit return before the tax-filing deadline means you can avoid having to pay late-filing penalties.

2. Families - Save those receipts! All the activities you have been paying for throughout the year (piano, karate, tutoring, hockey, and more) may save you money at tax time.

3. Tax-free savings account - A tax-free savings account (TFSA) is one great way to save money since you don't pay tax on any income you earn from investments in your TFSA.

4. Registered retirement savings plan - Any income that you earn in a registered retirement savings plan (RRSP) is exempt from tax, as long as the funds stay in the plan. RRSPs help you save for your retirement and give you a break at tax time too.

5. Public transit tax credit - If you or someone in your family is a regular user of public transit, then you may be able to claim a non-refundable tax credit based on the cost of eligible transit passes.

6. Pension income splitting - If you receive income from a pension, you can split up to 50% of eligible pension income with your spouse or common-law partner to reduce the taxes that you pay.

7. Students - Are you still in school? Students can claim the tuition, education, and textbook amounts. Have you graduated recently? You may be eligible to claim the interest that you paid on your student loans.

8. Child care expenses - If you have children, you may be able to claim child care expenses that you or your spouse or common-law partner paid so that either of you could work, do research, or go to school.

9. Home buyer's tax credit - If you're a first-time home buyer you may be eligible to claim $5,000 on the purchase of your new home, which can save you up to $750.

For people who are self-employed:

10. Hiring an apprentice - Did your business employ an apprentice? A salary paid to an employee registered in a prescribed trade in the first two years of his or her apprenticeship contract qualifies for a non-refundable tax credit for the employer.

Tax Tip: Lean more about potential tax savings for tradespersons

Did you know?

As a tradesperson, you may be eligible for certain deductions.

Important facts

If you were a tradesperson in 2011, you may be able to claim a deduction for the cost of eligible tools (to a maximum of $500). For more information, go to www.cra.gc.ca/trades.

You can claim certain expenses you paid to earn employment income as a deduction, but only if your employment contract required you to pay for your own expenses, and either you did not receive an allowance for them or the allowance you received is included in your income. For more information, go to www.cra.gc.ca/employmentexpenses.

If you had expenses that included GST/HST in the course of your employment duties, and you deducted these expenses from your employment income, you may be able to claim a rebate of part or all of the GST/HST you paid on these expenses.

Keep all receipts and documentation to support the claims made on your return.

The deadline for filing your individual income tax and benefit return is midnight on April 30, 2012. However, if you or your spouse or common-law partner carried on a business in 2011, you have until June 15, 2012, to file your return. You must pay any balance owing for 2011 on or before April 30, 2012, regardless of your filing due date. In addition to these deductions, other credits, deductions, and benefits may be available to you. For more information, go to www.cra.gc.ca/trades.

Business Owners: The cold hard logic behind freezing your assets or Estate Freeze 101

The cold hard logic behind freezing your assets - written by Tim Cesnick and published in the Globe and Mail.

Paul is a close friend of mine. We don’t see each other often enough, but we got together for lunch this week. “Tim, I’m freezing my assets,” Paul said. For a minute, I was wondering if Paul was making a commentary on the sub-zero temperatures we’ve been experiencing. But that wasn’t it. Paul was actually freezing his assets. And I’m not talking about the fact that he left his lawn furniture and lawn mower out in the backyard this year to face the elements rather than putting those things away for the winter (he says he got busy and forgot).

 

No. Paul has decided to implement a tax manoeuvre called an “estate freeze.” Although it’s possible to “freeze” most assets, this is most commonly done by those who own shares in a private company and want to accomplish a few things. Let me explain.

The concept
Completing an estate freeze involves identifying certain assets – perhaps private company shares – and freezing those assets at their current value. When this is done, the future growth in value of those assets won’t accrue to you (the person completing the freeze), but will belong to others who you have chosen to receive that future growth. There are a number of benefits to this idea, but most notably you’ll pass the tax bill on that future growth to others. That is, you will have “capped” your tax liability on the assets frozen at today’s value.

The example

Paul owns the shares of a corporation that holds rental properties that he’s been accumulating over the years. The value of these properties is about $5-million today (net of any mortgages). He expects these properties to continue to grow in value in the future. Paul doesn’t need the income from these properties to support his lifestyle.

When Paul passes away, there’s going to be a tax bill owing on the shares of his corporation. After all, the shares are worth $5-million today (since the properties owned by the corporation are worth $5-million), but his adjusted cost base of his shares is nominal, at $100. In this case, Paul will owe about $1,160,227 in taxes upon death (he lives in Ontario and is in the highest tax bracket).
As the value of the properties grows, so will Paul’s expected tax bill on death. Paul decided to cap this tax liability by completing an estate freeze. How? Paul is going to exchange his common shares that he owns in his corporation for new preferred shares that are fixed, or frozen, in value (this exchange can take place without tax at the time of the exchange). These shares won’t appreciate in value as the properties grow in the future. Paul is going to issue new common shares in the corporation to his children. The future growth of the company will accrue to these common shares.
In actual fact, Paul isn’t going to issue the new common shares to his kids directly (although he could), but has decided to issue those shares to a family trust of which the kids are beneficiaries. This will allow Paul to continue to control those shares (as trustee of the trust) for the time being. He can distribute those shares out of the trust to the kids in the future if he chooses (this distribution can generally be done on a tax-free basis). But there are real benefits to having the trust in place to hold the shares today, including the ability to split income with the beneficiaries of the trust.

The nuances

Now, there’s more than one way to accomplish an estate freeze. Exchanging shares in an existing corporation for new frozen shares, as Paul is planning, is one method. It’s also possible in most cases to take assets that are currently outside of a corporation and transfer those assets to a corporation and take back, in exchange, shares in the corporation that are frozen in value. It may also be possible to place assets directly in a trust (without use of a corporation) so that the future growth will accrue to the beneficiaries, but this method may trigger a tax bill when transferring the assets to the trust if those assets have appreciated in value (in which case a corporation is likely the better route).
Freezing your assets won’t eliminate the tax bill that has accrued to date on those assets, but will stop the bleeding by passing the future growth to others who will likely pay the tax on that growth at a much later date than you. More on this topic next week.

Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.