Holding Companies and Canadian particularities
Holding Companies and Canadian particularities
A company that basically involves in holding investments from investors is a holding company and is distinct from an operating company. When holding companies hold investments of investors, operating companies actively get involved in business through multiple modes such as running consulting firms, Retail stores, etc.
As of the investments held by holding companies, there are different means in which a holding company receives investments. Listed down below are few among many.
⦁ Having shares in either or both private and public companies.
⦁ Other modes of investments like cash, term deposits, GICs or bonds that bring in investments.
⦁ Holding propriety of real estate like rental properties or lands rented for residencies or other commercial purposes.
Purpose of holding companies
A holding company serves different purposes in Canada.
⦁ Securing assets – assets are held in a holding company and not in an operating company, so that they are kept safe from creditors even if the operating company falls.
⦁ Assistance in claiming Lifetime Capital Gains Exemption/ LCGE – LCGE can be claimed by a business owner after proceeding through specific criteria offered by holding companies.
⦁ Savings related to Tax – related tax payments become lessened when incorporating a corporation to hold investments rather than holding them by the business person him/herself.
⦁ Tax deferrals – extensions to tax payments dues.
⦁ Estate planning – Passing the businesses to a new generation.
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Benefits and disadvantages of incorporating a business
Criterions to decide why or why not you should incorporate a business are crucial.
Benefits of incorporating your business –
⦁ Since your assets are held by an external party, you can avoid uncovering your personal assets, in a situation where your company is in debt
⦁ You are likely to save your cash spent on taxes as corporations enjoy low tax rates than individual ownership often times.
⦁ As of 2019, mentation of novel tax regulations regarding income splitting has caused a significant downtrend in cooperating small businesses, even though it has been the major reason to corporate businesses in previous years.
⦁ LCGE/ Lifetime Capital Gain Exemption – Business have the advantage of selling their businesses for a high tax free rates amounting to a gain of up to $866,912 if incorporated.
⦁ Estate planning benefits you especially in occasions where you plan to transfer your assets since a corporation’s survival does not depend on the state of your business and act as a separate entity.
Disadvantages of incorporating a business
⦁ Related costs – There are Incorporation and ongoing costs when incorporating a business that might come through as startup costs such as expenses of hiring lawyers to do documentation activities, and continuing costs such as annual legal filing fees.
⦁ Related activities – Time and attention requirements to supplement activities such as administration of legal and tax filing
⦁ Related complexities – Handling all complexities such as keeping record of asset values and recruiting professionals to handle them. Moreover, handling other issues such as increasing taxes is a given when cooperating businesses.
Your decision to incorporate
You might still find it difficult to decide whether you should incorporate your business or not. When your decision wavers between two ends, you might just opt to anyway incorporate your business because it has become the standard for businesses and therefore go with the trend. However, following the trend could turn out to be disadvantageous at times and also advantageous at other times.
To make it easy for you to figure out the right decision (CN) has taken few scenarios as examples to display on this site, so that you have further help to take a decision, trying to relate your situation to those that are stated below.
However, we highly recommend that your decision rely upon a thorough understanding by reviewing your situation with a professional like your accountant and lawyer, before taking such a crucial decision.
Limited Liability
This is one of many major reasons why business people tend to corporate their businesses. Accountability becomes an issue when your business is at stake of pursued by debtors in which case you will lose your assets. This is when limited liability comes into playing the hero.
You are saving your assets at hands of holding companies since you do not hold the liability of those assets and therefore save you from losing your cash.
This fact may vary in occasions where incorporated business directors are personally accountable for the debts of the business. For instant, when employee wages and vacation pay are not yet discharged by payment, because of payroll fees and collected GST/ HST owed to the Receiver General, and also when shareholders signed agreements with bankers and debtors to guarantee the recovery of mortgage and debts on behalf of the business.
These liability concerns promote incorporation at a greater rate.
Businesses built to put on sale
Huge tax benefits for incorporated businesses that are intended to put on sale.
Incorporation can save you from losing a lot of your cash to tax, if however you plan to sell the business that you are building.
Through LCGE/ Lifetime Capital Gain Exemption, you get a tax free profit of up to $867k if your business is operated through CCPC/ Canadian Controlled Private Corporation.
Eligibility to apply to LCGE
You are eligible to apply to LCGE if you pass the following tests.
⦁ Asset Test, which confirms that your business uses not less than 90% of company’s assets on active business at the time of the sale.
⦁ Basic Asset Test, which confirms that your business has been using not less than 50% of its assets on business for a period of not less than complete 24 months prior to the sale.
⦁ Holding Period Test, which confirms that the person who owns the business has held shares of that business for not less than 24 months prior to the sale.
Note – Holding passive investments instead of using assets in active business does not give the eligibility to apply to LCGE.
When your business profit exceeds your needs
If the business profit exceeds the amount that is required to fill the owners living expenses, the remainder is usually left in the company. If however, the remainder is put to the use of owner’s retirement as a saving, incorporation varies from that of other occasions and might save you from taxes.
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When the business is you
You are less likely to benefit from incorporation in occasions where you basically are your business; started and run on your own.
Losses for startups
Most businesses take their time to thrive. Meanwhile they experience losses at their hand. If this is a given to your kind of business, not incorporating your business is a wise choice.
If however, incorporation seems a must to your business and the losses can be personally born by the owner, then the proprietorship is at an advantageous line, in which case you can incorporate your business once the company starts profiting.
Real Estate Rental Business
It’s no secret that if set your foot on Real Estate business, that’s a cash spring. Therefore tax related queries regarding this field are common. Therefore people seek if incorporating Real Estate with which they get rental income is advantageous or not.
So to answer that, it may not be advantageous until you reach a certain magnitude in your business as the tax rates are considerably high.
If you are able to recruit at least a minimum of 6 employees as full-time workers, that could be taken as the indicator that you’ve reached a certain magnitude in your business to benefit from incorporating your Real Estate business.
One reason that turned out to be disadvantageous to operate a Private Corporation controlled by the Canada is imposing large amount of taxes on investment income than that of the business income. This is because small business deductions do not apply for tax imposing.
Therefore, it is often understood to be advantageous not to incorporate Real Estate Businesses.
Other factors that supplement this ideology are the relieves you get when you obtain mortgage on behalf of your business and the tax benefits you get when you live and/or lived in the rented property, in which case you are able to make use of Principal Residence Exemption.
These benefits are only liable to Real Estate Businesses; those that are owned personally instead of owned through a corporation.
Therefore personally owning your Real Estate Rental Business is better until you reach the milestone of being able to recruit at least 6 full-time employees to your business.
Dividends Vs. Salary/ Wages
You can choose either or a combination of both of these methods to pay yourself. They have their own pros and cons and business person can choose the righteous way which has the least negative impact on his/her business.
Salary
Paying yourself a salary is both an expense and an income. Difference is that the expense is to the corporation and the income is to the individual. Benefit is that the expense reduces the corporation’s taxable income that minimizes corporate taxes owing.
Procedure
It is important that the corporation opens a payroll account with CRA. Each of your wages may retain source deductions such as CPP and income tax which will then be dispatched to the Receiver General. (CRA) Moreover, T4s will be prepared and filed annually by the corporation for each employee.
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Why opt for a salary?
This is a stable and a predictable income generating method if you wish to acquire such benefits.
There are also other main advantages of paying yourself a salary.
⦁ Using this method opens up a chance for you to build RRSP contribution Room which is not allowed when taking a dividend.
⦁ This will also make you eligible to benefit from Canada Pension Plan/ CPP from which you’ll be benefitted at your retirement. This however, is also an expense to you and your corporation although the benefits come later.
⦁ Tax benefits is a given to this method. Since income tax is retained and remitted to the Receiver General from each wage, you’ll be free from surprise bills when filing your personal tax return. This is not a benefit enjoyed by choosing to pay by dividends.
⦁ Mortgage benefits can also be acquired by opting to receive a salary, as the bankers are usually required to be provided with a steady income plan.
Dividends
These are payments given to shareholders as a cut from the net profit. There’s no reduction to the corporate tax paid since they aren’t a corporate expense. Dividends have less personal tax liability than that of wages, since dividend tax credit is given to dividends.
Procedure
Shareholders will receive the declared dividend to their personal account from the corporate account of the business and thereby considered an easy method than paying a salary. T5s will be prepared and filed for each of the shareholder annually. However, share ownership account for the dividends received by each partner means that each partners’ share is equal to the percentage of their ownership. This could be tiring when different amounts of income need to be allocated to multiple shareholders if all the shareholders own the same class of shares.
Advantages of opting to dividends
Most common advantage is that it is an easy way to withdraw money for the shareholders from their corporation.
However, it also,
⦁ Comes with low cost benefits like avoiding corporate and personal costs such as CPP.
⦁ Turns out to be a simple method. For instance at occasions where an individual holds the entire ownership of the corporation, s/he can transfer the declared dividend to his/her personal account directly from the corporate account and avoid payroll or remit source deductions.
⦁ Gets rid of payroll penalties coming through late or missed payroll remittances. However, T5s need to be completed promptly annually.
When the dividend and wage payments are considered, there should be little to no difference in the income tax paid in occasions where both these types of payments amount to be equal. This is the thinking behind the new tax concept named integration. Income tax comes as a combination of personal and corporate taxes. They account for differences in tax calculation of dividends and wages as follows.
Personal tax amounts to higher rates in wages than in dividends, where as corporate taxes amount to higher rates in dividends than in wages.
Dividend Sprinkling
Corporate owners are high income owners, which also mean that they are heavy tax payers. However, there’s a way that these corporate shareholders used to divert their income to a spouse or to any other member in the family, specifically to someone with a low income, to get rid of heavy taxes imposed on corporate businesses. This is called dividend sprinkling, sometimes called income sprinkling. Since individuals who do not directly involve in corporate business do not account for heavy tax payments, corporate shareholders could reduce their personal taxes by resorting to this method.
Still there are more factors to consider before resorting to either of these methods; dividends or wages.
Tax calculations
It’s important to be aware how tax calculations happen for both dividends and wages in order for you to choose between either of those payment methods. There are tools to estimate the overall tax amounts for each payment methods. Overall tax amount is a composition of both personal and corporate tax. Addition of these two equals the amount of tax you are liable to pay. Personal and corporate taxes can be calculated through tools like SIMPLETAX CALCULATOR and CORPORATE TAX RATE respectively. Apart from using these tools and to be more confident about your tax expenses you can get your accountant to do the calculations for you.
Possible events to reconsider your payment method
⦁ In case you are likely to delay tax payments, it is better to opt for dividend payment method. Otherwise you’ll be liable to pay penalty charges for missed source deductions required to pay when chosen to pay yourself in wages.
⦁ In the event that you plan on buying a home soon and realize that you should fit the bill for a home loan, it might be smarter to pay yourself as a worker (wages). Banks like to see a frequent fixed income than an infrequent dividend payment.
⦁ On the off chance that you plan on having kids soon and you want to acquire Maternity or Parental advantages, at that point it might be smarter to pay yourself through wages. This is on the grounds that retaining and dispatching employment insurance premiums can empower the employee to gather Maternity or parental advantage.
⦁ There are occasions which may not apply to every situation where business owners are paid wages as a bonus in order to decrease or concede TAX.
⦁ Qualified working low income personals and families are given a refundable tax benefit called The Working Income Tax Benefit. You may want to gain this benefit in case you have a low annual income either personal or family vise. Paying yourself wages may account for you to qualify for this benefit so as to trigger it on your personal taxes.