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Investment Holding Companies Tax Implications of Investing Through a Corporation

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Investment Holding Companies Tax Implications of Investing Through a Corporation NavigatorThe INVESTMENT, TAX AND LIFESTYLE PERSPECTIVES FROM RBC WEALTH MANAGEMENT SERVICES Investment holding companies Tax implications of investing through a corporation Earning investment income through a corporation can be complex as you have to consider the taxes payable in the corporation as well as the taxes payable on withdrawing the funds from the corporation. This article outlines the major advantages and disadvantages of using an investment holding company for investments, and identifies situations where the use of an investment holding company may be beneficial. This article outlines several strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal or tax advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified Please contact us tax advisor before acting on any of the information in this article. for more information about the topics Investing through a holding corporation, the total corporate and personal tax payable should be discussed in this company An investment holding company is approximately the same amount as article. not a defined term in the Income what the shareholder would have Tax Act. It is a term used to describe paid if the investment income was a corporation that holds passive earned directly by the shareholder. assets, such as shares of another Accordingly, there should be no company. Typically, you would not material tax deferral opportunity be running an active business inside and/or taxes payable on passive a holding company. income earned in a corporation. This is the concept of integration, The Canadian tax system is designed which of course does not always to be neutral between investment work perfectly. In fact, in almost all income earned personally and provinces, the integrated tax rate for investment income earned through investment income earned through a corporation. What this means a corporation is slightly higher than is that after the corporation pays the personal tax rate for investment tax on its investment income and income. So why would anyone the shareholder pays personal tax consider having a holding company? on dividends received from the 2 | RBC Wealth Management Advantages of using an property to an investment holding investment holding company company and one of the main The following are some of the major purposes of the transfer or loan is to advantages of having an investment benefit a spouse or a related minor holding company. child (which includes a grandchild, niece or nephew) who owns 10% or Estate freezes more of any class of shares in the An investment holding company investment holding company. If One of the purposes of can be used to implement an corporate attribution applies, then an estate freeze is to estate freeze. One of the purposes the individual who transferred or “freeze” a company’s of an estate freeze is to “freeze” a lent the property to the corporation share value for the company’s share value for the original is deemed to have received interest original shareholders shareholders and pass on the future income in the year equal to the CRA and pass on the growth of the corporation to the prescribed rate of interest for the period on the outstanding amount of future growth of the next generation or to other desired the transferred property or loan. This corporation to the next individuals. This way, the capital gains triggered on the deemed disposition annual deemed interest benefit is generation or to other reduced by the following: desired individuals. of the shares upon death and probate taxes for the original owner of the ● Any actual interest received in the company may be minimized. Where year by the individual in respect of an estate freeze is done to benefit a the transfer or loan; spouse and/or minor children, the corporate attribution and “kiddie” ● Grossed-up taxable dividends tax rules discussed in the next section received by the individual in should be considered. the year on shares that were received from the corporation as Another use of an estate freeze consideration for the transfer; and is to crystallize the capital gains exemption on the transfer of ● Income subject to kiddie tax qualifying small business corporation (discussed below) reported by the shares. You may want to do so if related minor child. currently, your shares qualify for the capital gains exemption and you Another rule that restricts the ability expect that they will not qualify for to split income with minor children is the exemption in the future. It should known as the split income rule (also be noted that holding companies that known as kiddie tax). Under this rule, are used only to hold an investment a minor child who receives certain portfolio do not qualify for the capital dividend payments from a Canadian gains exemption. corporation whose stock is not listed on a designated stock exchange (e.g. As estate freezes are quite complex a privately held company) is taxed on transactions, they should only be the grossed-up value of the dividend undertaken with the assistance of a received at the highest personal qualified tax advisor. marginal tax rate. The parent is also jointly and severally liable with the Income splitting child for the taxes payable on the Certain income tax rules are designed split income. to discourage income splitting with spouses and related minor children Both the corporate attribution through the use of an investment and split income rules do not holding company. One such rule apply where the shareholders of is corporate attribution. Corporate the holding company are adult attribution generally applies when children. Therefore, it is possible an individual transfers or lends to split income with adult children RBC Wealth Management | 3 through the use of an investment a holding company. This may protect holding company without triggering those earnings from creditors of your the above mentioned adverse tax operating company. If the operating consequences. You may incorporate company needs working capital, a holding company and the adult your holding company can lend children can subscribe for the shares that money back to your operating of the company. It may also be company on a secured basis to possible to transfer certain assets maintain the potential protection to the holding company on a tax- from creditors. It is essential that you deferred basis to benefit your adult speak with a qualified legal advisor children. Income earned in the regarding any asset protection corporation can be paid as dividends options available to you. You may to the adult children and taxed in also wish to speak to a qualified tax their hands. advisor about the tax implications of Holding U.S. investments moving the funds from your holding There are also more sophisticated company to your operating company. in a Canadian corporation ways of structuring a holding may minimize or eliminate company that avoid the application U.S. estate taxes the Canadian shareholder’s of the corporate attribution rules with Holding U.S. investments in exposure to U.S. estate tax. respect to a spouse or minor children. a Canadian corporation may However, these structures are beyond minimize or eliminate the Canadian the scope of this article. In any shareholder’s exposure to U.S. estate case, as this area of taxation is quite tax. For more information on this topic, complex, it is strongly recommended speak with your qualified tax advisor. that you discuss these issues with a qualified tax advisor prior to Probate taxes implementing any strategies. In certain provinces, you may be able to reduce your exposure to Inter-corporate tax-free dividends probate taxes on death by using A common corporate structure a multiple Wills strategy. You may involves a holding company owning have a “Primary” Will dealing with shares of an operating company. assets that require probate to Incorporating a holding company transfer ownership, such as a bank into an existing corporate structure account or investment portfolio. A may be advantageous if you want “Secondary” Will may be used to to move assets or funds out of the transfer assets that do not require operating company but do not probate such as artwork or private necessarily want to pay personal tax company shares. Under provincial on the assets or funds. corporate statutes, it may be possible to transfer share ownership on death In certain circumstances, it may without probate. Using an investment be possible to move these assets or holding company in conjunction funds from the operating company with a secondary Will may therefore to the holding company as an inter- minimize probate taxes on death. corporate tax free dividend. Speak to Note that the probate taxes may your qualified tax advisor for more not be significant enough to justify information about the tax implications establishing an investment holding of moving assets between an operating company. The avoidance of probate and holding company. taxes should be viewed as a secondary Creditor protection benefit of using an investment holding company. If you have excess earnings in your operating company each year, you There may also be circumstances may want to move the excess funds to where the secondary Will needs to be 4 | RBC Wealth Management probated. For example, if your Will Disadvantages of using an contemplates that the shares or the investment holding company assets of the company be transferred While there are a number of to a trust set up in your Will, probate advantages to having an investment may be required by a financial holding company, there are also institution to open the investment disadvantages.
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