Operating and Holding Companies - Why They Make Sense

A business can be structured using an operating company and a holding company together, where the operating company runs the business and the holding company oversees it. Using this structure, an operating company, or opco, is a public facing corporation that carries out and is liable for all active business. Often, an opco is a standard business that sells a product or service. By contrast, a holding company, or holdco, is a behind-the-scenes corporation that holds usually 100% of the shares in one or more opcos. Rather than carrying out active business, the holdco allows for an opco’s shareholder(s) to make the most of the opco’s dividends, taxes, etc. Think of a holdco as an administrative tool that supports an opco by giving its structure an extra layer. Note that both opcos and holdcos are incorporated.

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To help illustrate some potential opco/holdco relationships, consider the following examples:

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Image 1

Let’s say Shannon is the sole shareholder in a company that sells handcrafted timepieces, called Freckle Past. If Shannon decides to use a holdco to manage her opco, she creates the structure in image 1 (right).

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Image 2

Now, let’s imagine that Shannon and Erika are equal shareholders of Freckle Past. Shannon and Erika have different ideas for managing their earnings, so they decide to each use their own holdco to manage their respective halves of the opco’s profit. That creates the structure in image 2 (right).

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Image 3

Finally, let’s say that, in addition to owning 50% of the shares in Freckle Past, Erika also owns 100% of the shares in a donut shop, Hole Foods. She decides to use one holdco to manage all of her shares, creating the structure in image 3 (right).

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There are several advantages to the opco/holdco business structure.

The first few benefits are related to the fact that dividends from an opco can be transferred tax free to a shareholder’s holdco. Whether an opco has one shareholder or multiple shareholders, a shareholder can transfer opco dividends to their holdco instead of directly receiving the dividend as personal income. Doing so does not mean that the shareholder earns no income. By contrast, since the shareholder has complete control over their holdco, they can decide when they want to use their dividends as personal income, and how much of their dividends they want to use as personal income. Below, we’ve outlined a few instances where this element of choice is especially beneficial:

Let's return to our example: We'll use the scenario where Freckle Past has two shareholders, Shannon and Erika, and each of them uses a holdco to manage their shares (image 2, above). Suppose that Shannon and Erika are trying to decide on the best time to pay the shareholders a dividend from the opco. Shannon feels that she needs personal income soon, but Erika does not—and does not want to pay income tax at present. Despite this apparent conflict, the shareholders will still be able to easily decide on a mutually convenient time for distributing the dividends from their shared opco, since the holdcos allow them to maintain their own income schedules. The next time that Freckle Past pays its shareholders their equal dividends (via their holdcos), Shannon can use her dividend as personal income while Erika can use her dividend to fund some investments.

1. When an opco has multiple shareholders, using holdcos means that the opco can distribute dividends when it is beneficial for the business, while shareholders can use these dividends on their own schedules, and in their preferred ways.
   

2. A shareholder who defers income tax when transferring their opco dividend to their holdco retains a larger amount of money to use before it becomes personal income (namely, to use on investments). Rather than taking the opco’s dividend as personal income, paying income tax on it, and then investing the remainder, the shareholder invests the money before it is taxed, grows it, and then has a larger sum to use.
   

3. A shareholder can reduce their own income taxes by distributing money from the holdco as income to several family members.

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Storing excess money from an opco in a holdco creates two more opportunities for shareholders:

First, removing non-essential assets from the opco can protect them from creditor and liability claims within the opco, as the assets stored in the holdco cannot be collected for opco claims.

Second, removing excess money from the opco also helps the opco to meet the criteria for a business whose share sales count towards a shareholder’s lifetime capital gains exemption. The lifetime capital gains exemption refers to the dollar amount of shares in a non-public Canadian corporation that a shareholder can sell tax free. This amount, which is capped at a set maximum and which carries forward indefinitely through all of a shareholder’s sales, only pertains to businesses that meet certain criteria. One such criteria is that assets in the business in question remain active, and removing excess money from an opco ensures that the remainder of the “purified” money is active.

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Using an opco/holdco structure presents many financial benefits for shareholders, but it adds some complexity to business administration (from legal and accounting perspectives, for example). If you would like to explore the possibility of using this structure in your corporation, our office would be pleased to discuss your options with you. Our extensive experience with corporate matters means that we can expertly guide you through the process of setting up and maintaining an opco/holdco structure.