BMO® Business Insights

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Feature Article

Holding company, family trust, or both:
Which option is best for you?

James Wong

by James Wong, Vice-President Succession Planning, BMO Harris Private Banking & Sharon Paterson, Regional Director Wealth Services, BMO Harris Private Banking

Businesses often begin as sole proprietorships and for legal, tax or other practical reasons, these businesses are eventually incorporated. As businesses grow, broader and more complicated structures involving holding companies and trusts may be introduced to segregate business assets and provide for tax-efficient income streaming. This article addresses some of the benefits and drawbacks of corporate reorganizations.


Creditor-proofing assets with a holding company

A "Holdco" is a corporation that is formed to hold specific assets or to hold shares of another corporation.

A Holdco is not necessary to defer taxes. Taxes can be deferred by retaining funds in an operating company; however, the downside to this is that these funds are exposed to creditors. By establishing a Holdco to own the shares of an operating company, a tax-free inter-corporate dividend can generally be paid to the Holdco to creditor-proof these funds. Alternatively, if shares are owned personally, dividends paid to creditor-proof these funds would be taxable. Done correctly, there should be no tax cost to transferring the shares to a Holdco.

In a multi-shareholder situation, the payment of dividends to several holding companies accomplishes a further objective of splitting up retained earnings into different "buckets" for future investment. Furthermore, adding additional shareholders (usually other family members) through a corporate reorganization can achieve income-splitting by paying dividends to lower-income family members that are over the age of 18 to take advantage of their lower marginal tax rates. It also provides access to multiple capital gains exemptions.

One drawback to holding excess cash at either the Holdco or operating company level is that it may affect the ability for the shares of the corporation to qualify for the $750,000 lifetime capital gains exemption on the sale of the business. Taxpayers should consult with their tax advisors well in advance of a sale to ensure this is appropriately managed.

Utilizing a family trust

In estate and tax planning for a family business situation, trusts may be used to involve other family members in a business for the future, multiply the access to the capital gains exemption in advance of a sale, and together with a holding company, creditor-proof corporate assets.

A trust is a separate taxpayer. An individual, the settlor, transfers property to the control of trustees to hold for the benefit of one or more beneficiaries. In a typical structure, the common shares of an operating company would be held by a family trust. The beneficiaries of the trust could include the business owner, a spouse, children, and a Holdco, subject to specific Income Tax provisions. Dividends may be paid to beneficiaries on a discretionary basis to take advantage of their lower marginal tax rates.

Structured properly, tax-free inter-corporate dividends can be paid by the operating company to the family trust and then paid to a Holdco. This accomplishes both the objective of creditor-proofing excess cash as well as keeping the operating company pure for purposes of claiming the capital gains exemption in the future. Furthermore, the trust structure provides access to the capital gains exemption of multiple beneficiaries.

For further information, contact your Commercial Account Manager, who can help address your unique needs with the support of BMO Harris Private Banking Private Wealth Consultants and the Wealth Services Team.

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