Ask three accountants in Peel whether you should have a holding company, and you may well hear “it depends” three times. They are right. A holding company can be a tidy way to protect surplus cash and organize a growing business. It can also be an extra set of books and a yearly bill that delivers nothing, particularly for an owner who spends everything the operating company earns.
The term also sounds more mysterious than it is. A holding company, often called a holdco, is an ordinary corporation, typically incorporated under Ontario’s Business Corporations Act or its federal counterpart. Its job is to own things, such as shares of your operating company, real estate, or investments, instead of selling goods or services itself. There is no separate “holding company” registration. The label describes what the corporation does.
This article is general information, not legal or tax advice. Tax rules shape almost every decision here, and they change, so a structure should only be set up with both a lawyer and an accountant looking at your actual numbers.
The Basic Picture
Imagine a hypothetical owner who runs a Brampton trucking and logistics business. Today, she owns 100% of Opco directly. In a holdco structure, she owns Holdco, and Holdco owns some or all of Opco. Opco keeps doing business, signing contracts, employing people, and carrying the risks. Profits it does not need can move up to Holdco as dividends.
That movement of money is the main reason people use this structure. A taxable dividend paid between connected Canadian corporations can often be received with no immediate corporate tax, because the Income Tax Act generally allows the recipient a deduction for it. Tax may still arise under Part IV of the Act if Opco received a dividend refund when paying the dividend, and a special anti-avoidance rule, subsection 55(2), can turn certain dividends into capital gains. Those are questions for the accountant to check before each significant payment.
Once in Holdco, the money is no longer tied to Opco’s business risk. It has not reached the owner personally, so personal tax has not been triggered on it. It may be paid out later, in a year when she needs it, and invested in the meantime.
Creditor Protection, and Its Limits
If Opco faces a lawsuit from a customer, a dispute with a landlord, or an insolvency, assets sitting in Holdco are generally not available to Opco’s ordinary creditors, because Holdco is a separate legal person. This is a real benefit for operating businesses with significant risk.
It is also easy to oversell. A few limits are worth keeping firmly in mind.
The dividend must be lawful. Section 38 of the Business Corporations Act prohibits directors from declaring a dividend if there are reasonable grounds to believe the corporation is, or after paying would be, unable to pay its liabilities as they become due, or that the realizable value of its assets would be less than its liabilities and stated capital. A director who approves an improper dividend can be personally on the hook.
Timing matters. Moving money out when Opco is already in trouble, or when a claim is coming, can be attacked under Ontario’s Fraudulent Conveyances Act, its Assignments and Preferences Act, the federal Bankruptcy and Insolvency Act, or the oppression remedy. The best time to take surplus out is when Opco is healthy and no one is at the door, and doing so as a regular practice looks far better than a sudden sweep.
Personal guarantees survive. If your bank or landlord holds your personal guarantee, a holdco does nothing to protect you from it. Lenders may ask Holdco itself to guarantee Opco’s debts too, which can pull the protected assets right back into the risk. Read any financing document before signing, especially one presented at renewal.
The structure does not shield you from your own acts. Directors have personal liability for unpaid wages and source deductions, and everyone is liable for their own wrongful conduct.
Keeping Property Out of the Operating Company
A common use in Brampton involves real estate. An owner who buys an industrial unit or a yard may be tempted to put it in Opco for simplicity. Then a large claim against Opco can threaten the property as well. Instead, Holdco, or a sister company with the same owner, can buy the property and lease it to Opco at a documented rate.
This requires a written lease on commercial terms, actual rent payments, and tax advice on how the rent is treated. Rental income can be passive income, unless the related-company rules recharacterize it, and each arrangement should be reviewed on its own. Land also raises questions of its own about land transfer tax and HST if you later change which company owns it, so choosing correctly at purchase is much cheaper than moving it afterward.
What About the Tax Deferral?
Active business income of a Canadian-controlled private corporation is generally eligible for a low small business rate on up to $500,000 of income. Personal tax rates for many owners are significantly higher. If you leave after-tax corporate earnings in a corporation, you defer the personal tax until a dividend is paid. This deferral exists whether the money sits in Opco or Holdco. A holdco does not create it, but it does make it safer to accumulate.
There are limits. Associated corporations generally must share the single $500,000 business limit, and Holdco and Opco will generally be associated. You cannot multiply the small business deduction by splitting a business into several companies.
Investment income is another trap. Since 2019, the small business limit is reduced where a corporation and its associated corporations earned more than $50,000 of passive investment income in the previous year, by $5 for each dollar over that amount, reaching zero at $150,000. Moving your surplus to Holdco does not avoid this, because the associated group is counted together. Someone with a large investment portfolio inside a corporation may need to be careful about which investments it holds. Passive investment income also attracts a high rate of tax in the corporation, partly refundable when dividends are later paid.
Income splitting with family members has also been narrowed by the tax on split income rules. Giving your adult child or spouse Holdco shares does not necessarily mean dividends are taxed at their rate. Get advice on this before you issue any shares to a relative.
The Trap: Your Capital Gains Exemption
For many owners, this is the most important issue in the article. Individuals who sell qualified small business corporation shares may be able to claim the lifetime capital gains exemption, which the federal government has set at $1.25 million for dispositions on or after June 25, 2024. Three points follow from that.
First, only individuals claim the exemption. If Holdco sells Opco’s shares, Holdco cannot claim it. That is an obvious problem if your plan is to sell Opco to a third party, and a buyer will usually prefer to buy Opco shares directly. A sale of Holdco’s shares by the individual owner may be possible if Holdco itself qualifies, but buyers do not always want that.
Second, to qualify, shares must generally meet detailed tests. At the time of sale, substantially all (90% or more) of the fair market value of the corporation’s assets must be used in an active business in Canada, and during the previous 24 months, more than 50% must meet that test, with stricter versions where holding companies are involved. Shares generally must also not have been held by anyone other than the seller or related people during those 24 months.
Third, those tests are the reason for moving excess cash out, called “purifying” the company, in the first place. A Holdco that accumulates investments may itself fail the test. An owner with a stacked structure should monitor this every year, well before any offer arrives.
How to Put One in Place
The share transfer into a holdco is the part that can trigger tax if handled poorly. If you simply transfer Opco shares to Holdco, you could realize a gain immediately. A tax-deferred rollover under section 85 of the Income Tax Act usually allows shares to be transferred at an agreed amount, but it comes with its own conditions and a joint election with filing deadlines.
A new business is easier. If you are starting from scratch, you may be able to incorporate Holdco first and have it subscribe for Opco’s shares on day one. A reorganization of an established company normally takes more thought. The steps generally include:
- incorporating Holdco and organizing its by-laws, directors, and first shares
- valuing Opco and designing the rollover with your accountant
- reviewing the existing shareholder agreement, bank covenants, leases, and licences for change-of-control consents
- making the transfer, signing an election and updating Opco’s securities register
- preparing the register of individuals with significant control for both corporations, because Ontario requires it
Costs and Family Consequences
A second corporation means a second set of financial statements, a second T2 return, a second minute book, and a second annual return. It can be worth it where surplus or risk is meaningful, but it is a poor deal for an owner whose business takes out nearly every dollar each year.
Holdco shares are also property. On separation, they can form part of net family property, and on death, there is a deemed disposition unless a rollover to a spouse applies. A holdco may help or complicate these issues, and it should be considered together with your will, any marriage contract, and your wider succession plans.
A Practical Way to Decide
You are more likely to benefit where Opco regularly earns more than you need to live on, your industry carries real liability, or you plan to hold real estate or investments separately. You are less likely to benefit if you take out all profits, Opco’s risks are minimal, or a sale is near and you need the exemption to be available without complication.
Bring your last two sets of financial statements, your shareholder agreement, and your personal goals to the conversation. From there, our corporate law group can coordinate with your accountant on the legal steps of forming and organizing the structure, and you can contact us to start that discussion.