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Why You Need a Holding Company

written by John Chow on March 24, 2008

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This is a continuation post of my blog series about running your blog as a corporation. While most bloggers are not at this stage yet, it’ll come in handy when you finally reach it.

Aside from the limited liability a corporation offers, the other benefit for setting one up is they are taxed at a lower rate than employment income. In Canada, the rate is so low it’s almost bordering on ridiculous (not that I’m complaining). A Canadian Controlled Private Corp is taxed at just 15.5% on its first $400,000 of net income. If you made that much as an employee, you’ll be at the maximum 50% tax rate.

Because of the huge gap between corporate and personal tax rates, many corp owners choose to withdraw minimum amounts for themselves and keep the rest of the profits in corporate retain earnings. However, doing it this way will create problems down the road.

Losing Operating Company Status

The 15.5% corporate tax rate only applies to operating companies, These are companies that exist to provide a product or service. The problem comes when the cash build up in retain earnings become so great that you are no longer considered an operating company for tax purposes. An example should better explain this.

Say the corp is netting $300,000 a year after tax and dividend payments. It’ll be pretty stupid just to leave that money sitting in the bank. At the very least, you would put it in some kind of investment to earn some interest on it – like a T Bill or bond. As the years goes by, and with more company profits piling in, this chunk of cash will get bigger and bigger and account for more and more of the corporate income. If retain earnings were allowed to build up to $3 million and the company can make 10% return on that money, it would mean the company’s interest income would match its operating income. At this point, the tax man can rule that you are no longer an operating corp but a holding corp instead. A holding corp is taxed at a much higher rate than an operating corp (it’s still lower than the personal rate however).

Another problem that can come up if you keep too much retain earnings is potential lawsuits. Blood sucking lawyers love suing companies that have a lot of cash. The solution to all this is to get the money out of the company without incurring a tax liability. You do this by setting up a separate holding company.

No Dividend Cap On Holding Companies

The holding corp’s sole purpose is to invest the after tax income of the operating corp. While there are limits on how much tax-free dividend an operating corp can pay an individual, there are no limits on how much an operating corp can give its holding corp – you can transfer up to 100% of the retain earnings to the holding corp without incurring a tax liability to the holding company. The holding corp would then invest that money and any income made will be taxed at the holding corp rate. The operating corp will be able to retain its operating status and lower tax rate.

The above applies to Canadian tax laws. In the US, Uncle Sam would never declare your operating corp a holding corp. This is because the tax rate on a holding corp is lower than an operating corp. As with all financial advice, please see a qualified professional to find the best plan for you.

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{ 33 comments }

Eastwood March 24, 2008 at 11:14 pm

excellent post, John! your posts on the business and taxation side of e-commerce are quite interesting

Drunk College Girls March 26, 2008 at 8:10 am

Hi John, it would be very interesting if you would blog about how you put your money back into your corpoaration. I love these taxation posts, I think you are the only Big-time Blogger on the net currently blogging about this!

Andrew Pavelski March 25, 2008 at 12:08 am

Though I’m not at this stage yet, it was definitely great to hear about this topic from your Canadian perspective John.

Robert March 25, 2008 at 2:01 pm

By the way, why on earth are Canadian corps taxed at 15.5% at the low tier and American corps taxed at 35%??? Absurd. No wonder American companies keep exporting jobs overseas. To save money.

xtine March 25, 2008 at 12:52 am

i envy you johnchow. my google adsense got disabled. bleeh me

king kong March 25, 2008 at 1:40 am

wow, i am not even close to that yet, definitely a good read!

Shane March 25, 2008 at 2:03 am

Great stuff John,

The great thing about a holding corp is it can insulate your risk by owning all your assets (like a building, equipment, etc) and lease them to your operating company. That way, if someone sues your operating company, there’s less to get.

I think the best way to cut the tax bill is to have very little profit … and that’s the magic of growth; investing your profits back into the company to build more income streams turns all that revenue into expenses. No tax. Just high-octane growth.

Vista Sidebar Gadgets March 25, 2008 at 4:12 am

True to that. If you can re-invest most of your profits and turn them into expenses, then you can get a huge growth out of it. Better than an RRSP if you ask me! ;-)

Simon March 25, 2008 at 4:00 pm

A lawsuit could still go after your holding company with your assets by something your operating company did, as it would be pretty easy to “pierce the corporate veil” as both companies would have the same owners.

Art of Webhosting - Jeremy March 25, 2008 at 2:24 am

I like to read about things like this as I’m a law student/wannabe dot com mogul, and I’m thinking of moving to Canada in a few years. :cool:

Budi Putra March 25, 2008 at 3:54 am

I agree with you, John. To become more bigger and capable, bloggers should consider to adopt traditional business model like forming a company, holding company, etc.

Vista Sidebar Gadgets March 25, 2008 at 4:03 am

So John, when will you be incorporating a Holding Corp then?

It’s always nice to get some advice like that, helps you see how things are going to be structured once your venture gets rolling good.

Syed Balkhi March 25, 2008 at 4:49 am

Uncle Sam likes to have heavy pockets … and thats why I will be taxed at a higher rate :p

Robert March 25, 2008 at 2:08 pm

That’s why being an employee isn’t the way to go. The tax laws are written to enourage people to be investors and business owners.

Simon Lau March 25, 2008 at 4:58 am

That’s a good post, many of us are still ways away from getting ot the point of devloping a holding corporation but it’s never too late to plan for the future.
At the end of the day, it still sorta sucks that if you want to pull the money out for some personal expense, you get hit with the high tax rate. Canada should just ease back on the personal rates :)

David Chew March 25, 2008 at 5:31 am

That only is good when your blog is earning a lot.

Robert March 25, 2008 at 2:08 pm

Isn’t that the goal, though?

Motorycle Man March 25, 2008 at 6:20 am

That’s only useful when you earn enough money with your online ventures.

michael March 25, 2008 at 8:22 am

say you have a website and want to incorporate. how do you set it up that the website is owned by the corporation? this is for canada, ontario specifically.

Simon March 25, 2008 at 4:02 pm

Make sure the corp is paying all the fees, the domain, hosting, and server all say the company name on the accounts. Logo copyrights are all transferred over to the corporation.

MillionDollarJourney March 25, 2008 at 8:59 am

John, do you know the tax rates for holding corps?

Robert March 25, 2008 at 9:53 am

Good info, John. As always, corporations are great tools for paying less taxes. It’s a bit different in the U.S., but American corporate structures provide similar benefits.

Ingrid Riley March 25, 2008 at 10:01 am

What a few of my fellow Caribbean bloggers and tech entrepreneurs do is to register their dotcom businesses in a low tax countries like Anguilla and St Lucia and do all their transactions from a registered business there. They have a 1% company tax policy! I am based out of Jamaica and Atlanta and will be following suit in a couple of months.

vrempire March 25, 2008 at 11:53 am

Hmmm..if I can generate constant cash flow out of my site, then I wil read back this article very very seriously :)

Fei March 25, 2008 at 12:50 pm

Wow, i’m just a newbie about blogging, your post gave me a long vision, i have to learn a lot from you, Thank You…

Nick March 25, 2008 at 5:00 pm

Okay John if you keep this up you’re going to have to make a post about ways a US citizen can break free from the iron claw of Uncle Sam and set up shop in Canada.

Trust me, all of us “down here” (at least the successful one’s) are franticly looking for a way to escape.

Terry Tay March 25, 2008 at 5:09 pm

Your posts on tax are very informative. I’m not yet in your league when it comes to online earnings, but learning different tax tips along the way is very helpful.

With regards to leaving large amounts of money in the bank. It’s almost the same as sticking it in a sock and putting it under your mattress. It doesn’t do anything for you.
~Terry

estetik March 25, 2008 at 5:19 pm

A lawsuit could still go after your holding company with your assets by something your operating company did, as it would be pretty easy to “pierce the corporate veil” as both companies would have the same owners.

estetik March 25, 2008 at 5:21 pm

This was actually quite informative. One of the things that users can do is take advantage of Yahoo’s (my.yahoo.com) portal page where they can add your feed and it will be checked regularly for updates. This is also beneficial to you, the blogger, because as individuals add you to their my.yahoo.com, yahoo will spider your blog more often and add your entries to their search database, increasing natural traffic.

Jovan March 25, 2008 at 5:39 pm

good, one, and no wounder for sure, why US corporations export jobs overseas

John Esberg March 26, 2008 at 6:13 am

Wow, this was some interesting business advice. I’m quite impressed.

InvestorBlogger April 1, 2008 at 9:19 am

Does your holding company also need a holding company? :D

cyri jones April 1, 2008 at 11:35 am

Thanks for the info on holding companies. Maybe you could do a follow up posting with links to related articles / resources. I have been researching this for awhile with not much luck finding good info that applies specifically to Canada. I am in the process of setting up a holding company and three operating companies. I also want to set it up so that the operating companies own a small percentage of the holding company and the holding company owns a large percentage of the operating companies. This is where the laws get confusing… any tips or even tax expert referrals would be appreciated.