Like many entrepreneurs, Roger Hardy has worked hard to build his company. Since founding ClearlyContacts.ca in 2000, he has grown the Vancouver-based online seller of contact lenses and eyeglasses into a public company with annual revenue of $102 million. Along the way, Hardy’s company has developed significant assets. Worried that a big chunk of his business is conducted in the highly litigious U.S. market, he took steps to protect some of those assets from creditors by creating a personal holding company (PHC). Fortunately, while this “corporate veil” has never been attacked, says Hardy, “It lets me sleep at night.”
For business owners, a PHC can be the cornerstone of any financial plan. Typically owned by one or a small number of private shareholders, a PHC sits between an operating company and its shareholders, and earns income from passive sources such as dividends, royalties and rent. It’s a powerful investment tool that provides creditor protection and tax relief, and it can help you achieve your retirement-planning and succession goals—all at the same time.
“A holding company is part of the life cycle of a successful business,” says Craig Hermann, tax partner with Saskatoon-based Hergott Duval Stack LLP. It’s best suited to an entrepreneur whose company generates more after-tax cash and investments than the owner needs to live on, or has enough assets that can be logically spun off to make it worthwhile, given the costs of incorporation and annual maintenance fees.
The most common PHC assets include cash, securities, real estate, equipment, intellectual property and shares of your operating company. As with any other corporation, tax laws require personal and corporate transactions to be kept separate, meaning it can’t hold your RRSPs or other personal-use assets.
After-tax profits generated by your operating company can be transferred tax-free into the PHC. The cash can then be invested, grow and be taxed at the corporate tax rate—a significant savings over drawing them out and paying taxes on them personally. Dividends can be paid to you tax-free from the PHC’s capital dividend account or at a tax-efficient rate at retirement, presuming you are then in a lower tax bracket.
A PHC can be a good vehicle for sharing the wealth. If a lower-income spouse or other family member is a shareholder, dividends can be paid to them, typically at a lower tax rate than yours. While complex income attribution rules apply to both spouses and minors, says Hermann, “It’s still a great opportunity to achieve some income-splitting.”
Putting excess earnings into a PHC also protects your operating company’s status as a small-business corporation, reducing its taxes payable and ensuring your eligibility for the $750,000 lifetime capital gains exemption on the sale of your shares.
But there are important caveats: since only individuals, not corporations, can claim the exemption, be sure to hold at least $750,000 worth of shares personally, instead of in your PHC, advises Hermann. And don’t wait until there’s a buyer in the wings to transfer assets to PHC, he says. “You may not be allowed to move dividends up to a holding company on a tax-free basis if it’s part of the same series of transactions in which you’re trying to sell the company.”
Access to capital is another PHC benefit. If either you or your operating company needs capital, says Paul Mahaffy, a certified specialist in corporate and commercial law practising with Bennett Best Burn LLP in Toronto, the PHC can lend the funds back on a secured basis. (Funds lent to you, as shareholder, must adhere to the government’s prescribed annual interest rate.) So, says Mahaffy, the PHC is like a holding tank, “and the tap can be turned on or off, depending on the needs of the shareholder or operating company.”
Real estate or patents held within your PHC can make your operating company more affordable or feasible for potential buyers when it comes time to sell the business. In addition, these assets can earn investment income if they’re leased or licensed back to the operating company.
The cost you’ll pay to setup and maintain your PHC depends on how complex the corporate restructuring is; legal and accounting fees rise with each transaction. Hardy, for example, paid $20,000 to set up and structure his PHC, and pays another $7,000 to $10,000 per year in maintenance fees. Despite the cost, he says, “The benefits are well worth it.”
Hardy sees his holding company as part of his succession plan for passing wealth and shares to his children, now aged three and six. One day, he hopes they’ll be the mind and management of it, and actually at some point draw salaries from it: “That’s my long-term vision.”
In fact, Hardy says he hasn’t seen a downside to his PHC. “It’s a safe haven, and lets me feel like I’m planning for my children’s future,” he says. “It really is peace of mind.”