For those who are business owners and have corporations, a next step to take advantage of tax law may be to set up a
holding company. In the Small Business Needs section I will discuss the benefits, along with the disadvantages,
of owning a holding company.
Most Canadians believe that the sale of their home or “principal residence” is a tax-free sale, or is it? In the Personal
Income Tax section, I will attempt to clarify the principal residence exemption.
What is a holding company? A holding company can own the shares of your active business corporation, instead of you
owning the shares of your active business directly. It can be established that you own shares of the holding company,
which in turn owns shares of your active business corporation. For the discussion that follows, I will be referring to your
active business corporation as Opco (short for operating company), and the holding company as Holdco.
The Benefits of a Holding Company
Tax-Free Dividends and Delay of Paying Personal Income Tax
Similar to receiving dividends from owning stocks on the public stock exchange, your private corporation can pay you
dividends according to your share ownership. When you make draws from your corporation, those draws generally have
to be reported in your personal income in the form of a salary and/or dividend. I will leave the discussion of salary versus
dividends in my next newsletter. To keep things simple, say you withdrew $30,000 from your active operating corporation
(Opco) during the fiscal year, and you and your accountant decide that it will all flow to your personal income as a
dividend. If you own the shares of Opco directly, then any payment of dividends from that corporation, which in this case
is $30,000, 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 (Holdco) that owns your shares in Opco, and the $30,000 was paid as a
dividend to your holding company, our tax law allows that $30,000 dividend to be tax-free to your holding company.
The rationale behind the tax law is that it prevents the double taxation of corporate income, because the income that
gave rise to the dividends has already been taxed. Think of your holding company as a place to park draws from your
operating company without any immediate tax consequences. When you need money from your Holdco, then your Holdco
pays you, the owner of the Holdco, a dividend at your discretion which gets taxed in the year you receive it in the future.
This allows for a deferral or delay in paying personal tax on the dividends, which is 32.57% in 2010 for someone in the
highest tax bracket.
Flexibility for Multiple Shareholders with Different Cash Flow Needs
If you are one of multiple shareholders in your Opco, setting up a personal holding company for each shareholder can
provide flexibility for all shareholders with different cash flow needs. In our example above, if there are three
shareholders that own Opco, each with a third share ownership in Opco, the $30,000 dividend would have to be paid out
according to their share ownership, so one third of the $30,000, or $10,000, would be taxed in each shareholder’s
hands in the year it is paid out. If, on the other hand, each shareholder owned a holding company, which in turn
owned a one third share ownership in Opco, the $10,000 would be paid to each of their respective holding companies on a
tax-free basis, and parked there. Based on each shareholder’s personal cash requirements, they have control on
the timing of their personal income, when and how much to pay themselves from each of their holding companies.
Family Income Splitting
More than one person in your family can be a shareholder of your holding company, thereby shifting income to be taxed in
the hands of lower tax bracket family members such as your spouse or children. With respect to children under 18 years
of age (minors), dividends paid to them will be taxed at the highest marginal tax rate (“the kiddie tax” introduced in 2000).
However, once they reach 18 they can receive up to $37,485 of dividends tax-free (in Ontario) if they have no other
income, and if they are students with tuition of $7,000 and no other income, the tax-free dividend increases to $43,566 (in
Ontario). These amounts vary every year.
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