Holding Company - what is it?

Here is a great article written by Rolland Vaive, CA, TEP, CPA - an excellent accountant based in Ottawa (Orleans) and specializing in complicated tax matters.

Speak to any tax accountant for more than a minute and they'll surely be talking about holding companies, or HoldCo's for short. A holding company is not a term which is defined in the Income Tax Act. It is a term which is used to define a corporation which holds assets, most often income generating investment assets. It does not typically carry on any active business operations.

A HoldCo can arise for a variety of reasons. In the early 1990's, the personal marginal tax rate in Ontario was slightly higher than 53%, while the corporate rate of tax was considerably lower than that. High income individuals who had significant investment assets could realize a tax deferral by transferring their investment assets to a HoldCo, particularly in situations where they did not need the income which was being generated by the investments. This breakdown between the corporate rate of tax and the personal rate of tax lead to many HoldCo's being formed.

HoldCo's may also come about as an effective means of creditor proofing profitable operating companies, as a result of Canadian estate planning, or as a means of avoiding U.S. estate tax and Ontario probate fees. Regardless of their origins, the investment income generating HoldCo is taxed in an unusual manner, which I will attempt to explain. The underlying concept of HoldCo taxation is called "integration". In general terms, integration means that an individual should pay the same amount of tax on investment income if they earned it personally or if they earned it through a corporation and withdrew the after-tax income in the form of dividends. When we look at some real numbers, you will see that this in fact generally holds true. However, it is possible to exploit some breakdowns in integration, at which time it may become quite beneficial to earn your investment income through a HoldCo.

Let's look at the theory. We often hear about how corporations are taxed at low tax rates. In situations where a private company is earning income from active business operations carried on in Canada, that is quite true. In these situations, the rate of tax would be a flat tax rate of 18.620% if the company was resident in Ontario. The other provinces have similarly low rates of tax on "active business income". The low rate of tax does not apply to investment income, which is what the HoldCo would be generating.

For an Ontario resident private company generating investment income, the combined Federal and Provincial rate of tax would be a flat 49.7867% on all forms of investment income, other than dividends from other Canadian corporations. Bear in mind that only 1/2 of capital gains are included in income, so the effective corporate rate of tax on capital gains would be 24.8934%. A portion of the tax that HoldCo pays each year on its' investment income goes into a notional pool called the RDTOH pool. This is an acronym for "refundable dividend tax on hand". Of the 49% rate of tax that is paid by the corporation, 26.67% will go into the RDTOH pool each year and is tracked on the corporation's Federal tax return.

If HoldCo pays a taxable dividend to its' shareholders in a particular year, it gets back part of its RDTOH pool. More specifically, the company will get back $1 for every $3 of dividends that it pays. This RDTOH recovery is called a dividend refund, and would be a direct reduction of the corporation's tax liability for the year. If the corporation pays a large dividend to a shareholder, the dividend refund would also be large and may result in the company actually getting money back from the Canada Revenue Agency. In short, the HoldCo will pay a large tax liability on its investment income up front, but it can get a large portion of it back at a later date if it pays out dividends. The dividend refund is an attempt to compensate for the fact that the dividend will attract tax in the hands of the shareholder. Without this mechanism, the 48% rate of tax on investment income combined with the tax paid by the shareholder on the dividend that they receive would result in an onerous rate of tax. It is possible that a second notional tax pool may arise in HoldCo if it is generating capital gains on its' investment assets. You will recall that only 1/2 of capital gains are included in income. The other 1/2 portion of the capital gain which is not included in income will get added to the capital dividend account, or "CDA", of HoldCo. The CDA balance is something which needs to get tracked by the company on a regular basis, since it does not appear anywhere on the company's financial statements or tax returns. The CDA is important because it is possible for HoldCo to pay a dividend to a shareholder and elect to pay it out of the CDA balance, making the dividend tax-free to the shareholder.

If a company realizes a capital gain of $10,000 , only $5,000 will be included in taxable income, with the remaining $5,000 being added to the company's CDA balance. The company could then pay a $5,000 dividend to the shareholder. By electing to do so out of the CDA balance, the shareholder would not be taxed on the dividend. Lets look at this in conjunction with the RDTOH balance. If the company pas a dividend to a shareholder out of the CDA balance, it is tax free to the shareholder, but it is not going to generate a dividend refund to HoldCo. HoldCo only gets a dividend refund if the dividend is a taxable dividend to the shareholder. Armed with this theory, we can look at a live example of how this would work.

Lets consider the example of an Ontario resident individual who is holding shares that have an adjusted cost base (i.e. tax cost) of $1,000. These shares have experienced a dramatic increase in value, and are now worth $100,000. The individual is going to sell these shares and would like to know if there is any advantage to doing so through a HoldCo. The individual is in the highest marginal tax rate (currently 31.310 % on Canadian source dividends and 46.410 % on everything else).

The individual wants the after tax money, so they would withdraw everything from the HoldCo once the shares are sold. If they were to go the HoldCo route, they would elect to transfer their shares to HoldCo at their $1,000 tax cost prior to the sale (to transfer them at fair market value would defeat the purpose), and would have the capital gain realized within HoldCo. In the process of transferring the shares to HoldCo, they could arrange to have HoldCo issue a note payable to them equal to their original $1,000 tax cost. Integration tells us that selling the shares through a HoldCo should give us the same result as selling the shares personally.

If the individual wants to get the money out of the HoldCo following the sale of the shares, they would elect to take part of the proceeds from the share sale out of HoldCo as a non-taxable repayment of their $1,000 note and as a non-taxable payment our of the CDA balance. The remaining cash would be withdrawn from the company as a taxable dividend, leading to a dividend refund in HoldCo. As this example illustrates, there is no advantage to using the HoldCo to sell the shares even without considering the professional fees associated with the HoldCo. So why do it? Well, there may be some good reasons for doing it.

Firstly, the example assumes that the individual withdraws all of the cash from HoldCo in the year of the share sale, and at a time when they are in the highest marginal tax rate. If the cash from the sale was left in the corporation and withdrawn as a dividend a year or two later when the individual was not in the highest marginal tax rate, then the results may be quite good. The HoldCo would get the dividend refund at a rate of $1 for every $3 of dividends in that later year when the dividend is paid, and the shareholder may not incur a significant tax liability on the dividend that he or she receives. Alternatively, it may be possible to transfer the shares to HoldCo well before a sale is to happen.

In this way, future growth in the value of the shares could be shifted to other family members. When the shares are sold, the growth in value since the time of the transfer could be paid as a dividend to these other family members. If these family members are in a low marginal tax rate, they would not incur much tax on the dividend, and the results could be quite good when compared to the alternative where the shares continue to be held by the individual and sold by him or her personally.

There are a host of issues to be considered before embarking on such an exercise, including the corporate attribution rules and the tax on split income to name but a few. As always, seek professional advice before undertaking any steps.

Business Owners: Have You Ever Had a FREE Insurance Audit?

As a business lawyer, I am meeting a lot of entrepreneurs and I always suprised to see how many do not have proper insurance in place (life, critical illness, disability insurance, etc) -Especially when the corporation could pay for it, therefore it's a expense for the company. Today, I would like to share with you a great article from my good friend Milan Topolovec: Milan has more than 25 years of experience and he is providing a FREE Insurance audit for you and your partners - I highly recommend Milan, you only need to setup an appointment and he will review all your insurance policies for you ... in addition, you will have no further obligations. This 30 minutes can save you a lot money and could protect your family and yourself in case of ...

Have You Ever Had An Insurance Audit?

Each year, consumers spend billions of dollars on life insurance products, often needlessly. Many of these individuals could not tell you what type of coverage they have or the amount they pay in monthly premiums. Had they taken the amount they are paying in premiums and invested it, greater attention would have been paid.

We are often called upon to prepare insurance audits and create reports which show all the details of an insurance portfolio. Do you know the value of completing a detailed insurance audit?

Let me take you on a short journey where you will learn what can happen when things are left to chance.

Insurance audits provide you with peace of mind and provide your executors with a detailed summary of all your coverage. On occasion, we discover policies that are active but forgotten by the client. On one such occasion, monthly premiums were being withdrawn for policies no longer required. We were able to assist a client in saving well over $20,000. As the monthly withdrawals were spread over several policies, it remained undetected by the client. If this were a single lump sum, the client would have noticed.

When was the last time you reviewed the beneficiaries on your life policies? There have been documented cases where ex-spouses remained beneficiaries through oversight. In one corporation, the policy on death was being treated as a $10-million taxable benefit to the six shareholders. Ouch!

Recently we were called upon by an accounting firm to create an audit for one of their clients who happened to be a doctor. A number of problem areas were discovered which had nothing to do with amount or type of coverage. This client was using personal after-tax dollars, and through structural error, leaving the proceeds payable at claim to the professional services corporation.
There may be duplication of coverage where you are paying for coverage that you will never collect. Let's assume you have a disability program through your professional organization and a group plan. The coverage is offset at claim time.

Have you stopped smoking? If so, have you applied for NON-smoker rates? What is the difference of "own occupation" and "any occupation" in a disability policy? You say that the company owners have a shareholders' agreement and life insurance coverage. Who is the owner, premium payer and beneficiary on your policies?

You may feel overly secure in the fact that you have long term disability coverage under your group insurance plan. Group long term disability plans exhibit reverse discrimination against executives and shareholders. Show me a dedicated executive who would be able to stay home for 17 consecutive weeks in order to collect the payout under the LTD of a group policy.
Critical Illness and Long Term Care programs are the newest players in the life insurance arena.

Did you know that plans can be created where premiums are a tax-deductible expense to the corporation?

Operating Company, Holding Company, Family Trust or Spousal Trust can all be used to acquire tax-effective insurance solutions.

Work with an insurance professional that is experienced, deals with a number of leading insurers and also understands tax as well as legal structures.

To schedule a complimentary Insurance Audit, contact Catherine Pierre at ext. 231.

Milan Topolovec, BA, RHU, CLU. TEP is president and CEO of TK Group, recognized nationally as premier underwriters of insurance solutions from leading providers. Milan can be reached by e-mail at Milan@thetkgroup.com or by phone at ext. 223. For more information about TK Group visit http://www.thetkgroup.com/

Great websites for Entrepreneurs

In today's world of business, knowledge is power... therefore, I refer a lot of my clients to these 2 great websites:

http://www.ted.com/ and http://www.evancarmichael.com/

Take the time to have a look, it's truly worth it.

Please provide me with your comments and/or suggestions of other website.

Happy holidays and all the best for 2010.

Cheers,
Hugues

The importance of updating your minute book !!

Did you know that...

The Ontario and Canada Business Corporations Act (the “OBCA” or “CBCA”) require that a corporation hold an annual general meeting of shareholders to approve financial statements; to ratify and approve all acts and proceedings of the directors; to appoint officers and elect directors for the next year; and to appoint auditors or accountants in lieu thereof. The company’s minute book is subject to audit by representatives of the Canada Revenue Agency, CPP, GST and EI at any time. Any payment made by the corporation on account of dividends or bonuses must be recorded, and all capital contributions or loans to the corporation must be evidenced. However, instead of holding an actual meeting, shareholders may sign resolutions to conduct the business of the annual meeting. In addition, each Corporation must file an annual income tax return with each of Canada Revenue Agency, the Ministry of Finance and each province in which it carries on business. Please confirm with your accountant that the proper annual tax returns have been filed for these years and whether there are dividends or bonuses which should be recorded.

When you use MinuteBookUpdates.com for your corporate minute book maintenance, you will be receiving the attention of experienced corporate solicitors and law clerks with over 50 years combined experience. We provide quick, accurate production of your corporate documentation and as well as access to a corporate solicitor should you have any questions. We work closely with your accountant and your lawyer to bring your corporate minute book and business up to date and in compliance with Ontario and Canada requirements.

2009 -YEAR END TAX PLANNING

Further to my last entries, below is an excellent article written by Bessner Gallay Kreisman, Chartered Accountants :

Tax planning is most effectively carried out throughout the year, and the latter part of the year is an appropriate time to review various income tax and financial planning techniques that are available to individual and corporate taxpayers. Most tax planning transactions require analysis before being implemented so that they can be applied properly and in the right circumstances. For this reason, and since certain matters affected by the federal and various provincial budget proposals could differ from the actual law when enacted, all taxpayers should consult with their financial and tax advisors before initiating any of the strategies outlined in this issue.

PLANNING FOR OWNER-MANAGERS

Freeze or refreeze?

An estate freeze is used to ensure that future growth in the value of a company accumulates in the hands of a shareholder's heirs; it "freezes" the current fair market value of the company in preferred shares. In today's difficult economic environment, when the value of a business decreases substantially, the benefits of freezing are not fully realized, because new shareholders see the value of their shares fall. At such a time, it might be prudent to "unfreeze" the company and refreeze it. Refreezing enables taxpayers to exchange their old preferred shares, obtained at the time of the initial freeze, for new shares with a lower redemption price. Any future gains in value will then be passed on to the holders of common shares. This type of planning helps reduce tax on the death of taxpayers by lowering the redemption price of their preferred shares and transferring more value to their heirs.

The operations of unfreezing and refreezing are accepted by tax authorities and are not considered to be tax avoidance activities, provided that the redemption price of new shares issued at the time of refreezing is equal to their fair market value at that time and the lower value of the company is not the result of a dividend stripping operation.

Salary/Dividend planning

Many factors must be considered in determining the most beneficial combination of remunerating the owner/manager of a closely-held corporation. As with other planning, each case must be examined separately and no one "rule of thumb" can apply to all situations. Here are a few factors to be taken into consideration:

The tax rate of the corporation; the small business deduction (SBD) rate was increased to
$500,000 from $400,000 for active business income effective January 1, 2009

The tax rate of the individual

Exposure to Alternative Minimum Tax

The need for salary income by the individual to qualify for RRSP and CPP/QPP contributions or
to benefit from child care expenses

Wage levies applicable to salaries, such as the Ontario Employer Health Tax and Quebec's Health Services Fund and 1% Training Tax (if the payroll exceeds $1,000,000)

Quebec restrictions on the deductibility of investment expenses by individuals

Whether eligible dividends can be paid to shareholders

Full or partial loss of the dividend credit if taxable income is not high enough

Higher net income with a dividend than with a salary, dividend income is grossed up by 45% or 25% (depending on whether the dividend is eligible or not) which can have an impact on certain credits and benefits

Some planning techniques include: Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation's year-end. Where that year-end falls in the latter half of the calendar year (actually, after July 5), the corporation can cause the owner/manager's remuneration to fall into either the current or subsequent calendar year. The payment of dividends can be used to reduce or eliminate the owner/manager's CNIL, thus maximizing the amount of capital gains exemption that may be available to the taxpayer. To the extent that private corporations did not benefit from the small business deduction, the dividends paid from their active business income are eligible dividends that benefit from a lower tax rate. Since only Canadian residents may benefit from this type of dividend, it might be worthwhile to issue a separate category of shares for non-resident shareholders.

Income splitting

Investment income earned by an individual who invested money borrowed at low or no interest from a related person will be attributed back to the lender. Subject to a purpose test, this rule does not apply where the loan is to a related person other than a spouse or minor child. Nor will it apply where the loan is to a spouse or minor child if interest is charged at the prescribed rate in effect at the time the loan is made (the prescribed rate for the fourth quarter of 2009 is 1%). When utilizing this exception, interest must be paid no later than 30 days after the end of the year to avoid attribution of income. For instance, the high-income spouse could lend investment funds to the low-income spouse at the current 1% rate and receive (and pay tax on) the interest income each year, for as long as the loan remains outstanding. The low-income spouse would pay tax on the income generated by the funds and deduct the interest paid to the high-income spouse. Since the attribution rules are complex, caution is advised when contemplating a transfer of property or a loan to a spouse or a child (including transfers indirectly through a corporation or a trust). Some other basic planning ideas would include:

Gifting growth assets to a minor child, as the resulting capital gain is not attributed to the donor;

Gifting property to a child who is not a minor;

Segregating and re-investing "attributed" income of a spouse or minor child;

Deposit Canada Child Tax Benefit (CCTB), Universal Child Care Benefit (UCCB) and Quebec

Child assistance payments (CAP) directly into accounts opened in the children's names;

Use the income of the spouse with the higher income to pay all the family's expenses so that the
spouse with the lower income has more capital available for investment;

Using a trust for the benefit of family members to hold shares of a closely-held corporation.

However, there are restrictions in regard to income-splitting with minor children.

Spouses can choose to share their QPP and CPP retirement pensions. Income splitting may be achieved by having your spouse be your business partner or by having a business owner pay reasonable salaries to his or her spouse or children.

Shareholder loans

Any loan granted by a corporation to an individual who is a shareholder or to a person with whom the shareholder does not deal at arm's length will be taxable in the year in which the loan is advanced, unless one of the following exceptions applies:

The loan is repaid no later than 12 months following the corporation's fiscal year in which the loan was granted. It must be ensured that a new loan is not granted immediately to the shareholder to replace the old one, because the original loan will be taxed as if it had not been repaid

If the shareholder received the loan in his or her capacity as an employee for the purpose of purchasing a home, a car or newly issued shares of the corporation. However, this type of loan must be available to all employees and bona fide arrangements for repayment must be made at the time the loan is made

The loan is made in the normal course of the company's business activities
If the loan meets one of these exceptions, the shareholder will be required to pay to the corporation interest at a rate at least equal to the prescribed rate no later than January 30 each year. If a shareholder loan exists at any time during the year, a taxable benefit must be calculated based on the prescribed interest rate, less the interest actually paid. When a loan is repaid, the shareholder may claim a deduction up to the amount that had been included in income. It might be worthwhile for a corporation to make a loan to an adult child of the shareholder at a time when the child does not have much income. The loan may be repaid in a subsequent year, when the child's marginal tax rate is higher. Since shareholder loans are not deductible from a corporation's income, it is recommended that shareholders verify whether it would be more advantageous to be paid a salary or a dividend. It is very important that any loan contract between a corporation and one of its shareholders be adequately documented.

Capital gains exemption

A capital gains exemption is available for individuals to use in relation to gains realized on qualified small business corporation shares and some other properties. The maximum lifetime capital gain exemption is $750,000. Notwithstanding the income attribution rules, it may be advantageous to transfer a certain portion of qualifying growth assets to children to enable future capital gains to be exempt from taxation by utilizing the child's capital gain exemption. Consideration should be given to crystallizing a gain that qualifies for the exemption. Because of Alternative Minimum Tax (AMT), however, a crystallization may be more beneficial if spread over more than one year. Be aware of the possible disadvantage of selling investments eligible for the $750,000 capital gains exemption and investments with losses in the same year. Capital losses realized in the year must be offset against capital gains of that year including "exempt" gains, thus leaving a smaller amount available to claim the exemption against. Investments with losses should therefore be kept until the next year.

Capital gains rollovers for small business investors

To improve access to capital for small businesses with high growth potential, there exists a tax measure that, subject to certain conditions, permits individuals to defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business. The reinvestment in an eligible small business must be made at any time in the year of disposition or within the first 120 days of the following year.

Acquisition of assets

Accelerate the acquisition of depreciable property used in carrying on a business otherwise planned for the beginning of the next year. This will allow additional depreciation to be available to be claimed in the current year. The "available-for-use rules" should be considered (generally requiring the depreciable property to be used in operations for the depreciation deduction to be allowed). Eligible computers and software acquired after January 27, 2009 and before February 2011 are entitled to a capital cost allowance of 100% the first year in which the assets are available for use. Conversely, consider delaying until the subsequent year the acquisition of depreciable property in a class that would otherwise have a terminal loss in the current year.

Corporation tax on capital

In Ontario, the capital tax rate, which will be eliminated effective July 1, 2010, will drop from 0.225% of paid-up capital in 2009 to 0.15% for the first 6 months of 2010. Taxpayers affected are granted a $15 million deduction from paid-up capital. In Quebec the capital tax will be eliminated effective January 1, 2011. At the same time, the rate will fall from 0.24% in 2009 to 0.12% in 2010. A $1 million deduction applies to the paid-up capital of a group of associated corporations. A corporation with liquid assets at its disposal may reduce its capital tax if, before its fiscal year-end, it uses them for the repayment of certain liabilities such as shareholder loans or to purchase eligible investments. However, the corporation must have held certain of these investments for a continuous period of at least 120 days, including the date of its fiscal year-end.