Setting Up a Holding Company in Canada: When, How and Cost

How do you set up a holding company in Canada?

A holding company (holdco) owns shares and investments; your operating company (opco) runs the business. To set one up, incorporate holdco, then transfer your opco shares to it in exchange for new holdco shares. You and holdco jointly file Form T2057 to elect under section 85 of the Income Tax Act, so the transfer can happen at your cost and no gain is taxed now. The election is due by the earliest income tax return filing deadline of either party for the transfer year.

Once holdco owns opco, opco can usually pay dividends up to holdco free of corporate income tax, because holdco deducts them under section 112. Part IV tax and section 55(2) are the exceptions, explained below. You still pay personal tax when holdco pays dividends to you.

A holdco set-up is not simple when:

• opco's shares are already worth much more than you paid for them, so the value on Form T2057 matters;
• you want cash or a promissory note back from holdco, not only shares;
• a sale of opco or a new investor is in view;
• family members will own shares of holdco or opco;
• you live in Quebec, or either company is in Quebec: Quebec runs its own personal and corporate income tax, so the transfer can need Quebec filings too (CRA, corporations; CRA, individuals).

What to gather: opco's articles and share register, its financial statements and T2 returns since you got the shares, what you paid for your opco shares (their adjusted cost base) and their paid-up capital (usually the amount paid into opco for them, shown as share capital), an estimate of what the shares are worth today, and a list of every shareholder.

When is the right time to set up a holding company?

The usual triggers are:

• opco keeps more cash than the business needs, and you want that surplus held outside the operating company;
• a sale of opco or a new investor is coming;
• you are starting a second business and want one company to own both.

Some holdco plans work only if holdco is in place before a sale or investment is agreed. A dividend paid as part of the same series of transactions as a sale is what section 55(2) looks at (below). For the lifetime capital gains exemption and other pre-sale steps, see selling your business. Whether a holdco is worth it at all is covered in holding and investment corporations.

Which way should a holding company own the operating company?

There are two ways to put a holdco on top: move your existing opco shares into it, or have opco issue new shares to it.

Option (b) needs advice before anyone signs. If opco already has value, new shares issued cheaply to holdco can move that value away from your current shares, with tax results that depend on the facts. The usual first step is an estate freeze: you exchange your opco shares for fixed-value shares under section 86, so the new shares holdco takes get only future growth. If your fixed-value shares are worth less than the old ones and the difference benefits a related person, section 86(2) can tax you on it. The rest of this page covers option (a).

What are the steps to create a holding company, in order?

1. Value and cost. Get an estimate of the opco shares' fair market value, and confirm their adjusted cost base and paid-up capital. These set the range for the election and the limit on any non-share payment.
2. Incorporate holdco, federally or in a province (federal or provincial incorporation). A corporation formed federally or in Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario, Prince Edward Island or Saskatchewan gets a business number and corporation income tax account automatically; elsewhere, register with the CRA (CRA).
3. Organize holdco: directors, by-laws and share classes (share classes and family shareholders).
4. Sign a share transfer agreement. You transfer your opco shares; holdco pays with its own shares, including at least one share.
5. Record the transfer at opco. Get any approval opco's articles require for a share transfer, then update opco's securities register. A federal corporation's register must show the date and particulars of each issue and transfer (Canada Business Corporations Act, section 50). If the transfer changes a federal corporation's register of individuals with significant control, the change is filed with Corporations Canada within 15 days (Corporations Canada).
6. File Form T2057. You and an authorized officer of holdco both sign. It is filed separately from any tax return, by the earliest income tax return filing deadline of either party for the transfer year (IC76-19R3). Alberta, which runs its own corporate income tax, uses the federal elected amount; its Form AT107 is only for electing a different Alberta amount (Alberta CT-1).
7. Update both minute books with the resolutions and registers (section 20 for federal corporations; see minute book for a new corporation).
8. Open holdco's bank account and books. Holdco files its own T2 every year, even with no tax payable (CRA). From the next returns, opco lists holdco as a shareholder on Schedule 50, and both companies complete Schedule 9 for related and associated corporations (CRA T2 guide).

How does a section 85 rollover keep the share transfer tax-free?

Section 85 lets you and holdco agree on an "elected amount" that becomes both your sale price for the opco shares and holdco's cost of them. If you elect your cost and take back only holdco shares, no gain arises now, subject to the limits and traps below. The gain is deferred, not erased: your new holdco shares take that same cost.

The election works only if:

• holdco gives at least one share (or a fraction of one) as part of the payment (IC76-19R3);
• both of you sign and file Form T2057 on time;
• the elected amount sits inside the limits of section 85(1).

Electing above your cost creates a capital gain now; that choice has its own tests, covered in selling your business.

Without a valid election, section 85 does not apply. The automatic share-for-share rule in section 85.1 does not help either, because it does not apply when you control the buyer after the exchange (section 85.1(2)). The transfer is then an ordinary sale to a company you do not deal with at arm's length, treated as made at no less than fair market value (section 69(1)), so the whole gain is realized now and taxed as a capital gain.

A late election is accepted up to 3 years after the deadline if you pay the estimated penalty when you file. The penalty is the lesser of 1/4 of 1% a month of the amount by which fair market value exceeds the elected amount, and $100 a month up to $8,000 (section 85(7) and (8)). After that window, the CRA accepts an election only if it considers it just and equitable (section 85(7.1)).

If the value is disputed, a price adjustment clause in the agreement does not change the election by itself; the CRA expects an amended election under section 85(7.1) (IC76-19R3).

What can go wrong when you move opco shares under a holdco?

The traps are taking something other than shares, getting the value wrong, and timing.

Section 84.1 applies when you (or another Canadian resident that is not a corporation, such as a trust) dispose of shares of a Canadian corporation, held as capital property, to a corporation you do not deal with at arm's length, and the two companies are connected right after. A holdco you control will usually meet both tests. Any cash, note or other non-share payment above the greater of the opco shares' paid-up capital and your adjusted cost base is deemed a dividend to you, and holdco's new shares get reduced paid-up capital.

Once holdco owns opco, are dividends between them tax-free?

Usually, for corporate income tax: holdco deducts a taxable dividend from a taxable Canadian corporation (section 112(1)). Part IV tax and section 55(2) can still apply. When holdco later pays dividends to you, they are taxed on your personal return (section 82).

Part IV tax is set out in section 186. It goes into holdco's refundable dividend tax on hand and can come back as a dividend refund when holdco pays taxable dividends (section 129).

Section 55(2) can turn the part of an inter-corporate dividend above "safe income" (income earned that could reasonably be considered to contribute to the gain on the share) into a capital gain, when one of the dividend's purposes is to significantly reduce a capital gain or a share's value, or to raise the cost of property (section 55(2) and (2.1)). The Act gives a starting point for safe income (section 55(5)), but how much belongs to a particular share rests on CRA positions and court decisions, so it is not settled and is worth checking before a large dividend; see holding and investment corporations.

For paying and recording the dividend, see declaring and paying a dividend. For fees instead of dividends, see management fees between holdco and opco.

Do a holding company and an operating company share the small business limit?

Yes, when they are associated. A holdco that controls opco is associated with it (section 256(1)(a)), and associated Canadian-controlled private corporations share one $500,000 business limit (section 125(2) and (3)). They allocate it on Schedule 23 (CRA T2 guide).

Association also reaches corporations controlled by related people, such as siblings or spouses, when one of them also owns at least 25% of a class of shares of the other corporation, and in some cases of both, not counting certain fixed-dividend non-voting shares (section 256(1)(c) to (e)). Shares a holdco owns are treated as owned by its shareholders, in proportion to the value of their holdco shares, for these tests (section 256(1.2)(d)).

Holdco's own investment income, such as interest or dividends from companies it is not connected with, counts toward the passive-income test that can shrink the shared limit; dividends from a connected opco do not (section 125(5.1) and (7)). See holding and investment corporations.

What does a holding company cost to set up and keep?

Setting up costs a registry fee; keeping holdco adds a second set of books and a second T2 every year.

Either way, a share valuation is needed when opco's shares are worth more than their cost, to support the elected amount. Legal and tax help with the transfer costs more when opco is worth more, has more shareholders, or the deal includes cash, a note or family shareholders.

Sources: Corporations Canada fees, Ontario fees. For other provinces, see cost to incorporate in Canada.

Example

These examples are illustrative and use Canadian dollars.

An Ontario contractor puts her opco under a holdco

Her opco is worth C$800,000; her shares cost C$100 and have C$100 of paid-up capital. She incorporates a holdco in Ontario (C$300 fee) and transfers all her opco shares to it for holdco shares only. They elect C$100 on Form T2057 and file it on time: her proceeds are C$100, so there is no gain now. Holdco's cost of the opco shares, and her cost of the holdco shares, is C$100 each.

Next year opco pays holdco a C$200,000 dividend. Holdco owns all of opco, so they are connected; opco has no refundable tax and gets no dividend refund, so there is no Part IV tax. Holdco deducts the dividend. Assume a safe-income calculation supports at least C$200,000 on holdco's opco shares; on that assumption, section 55(2) does not turn the dividend into a gain.

Same contractor, but she takes back a promissory note

Holdco pays her with shares plus a C$150,000 note. The elected amount must be at least C$150,000, the note's value. Section 84.1 treats about C$149,900 (the note less the greater of her C$100 cost and C$100 paid-up capital) as a dividend from holdco to her, taxable this year even though the note is unpaid. Had the note been C$100 or less, section 84.1 would create no dividend.

Two brothers, each with his own holdco

Two brothers each own 50% of opco. Each forms a holdco and transfers his opco shares to it, so each holdco owns 50%. Each holdco owns more than 10% of opco's votes and value, so the holdcos are connected with opco and an ordinary dividend carries no Part IV tax unless opco gets a dividend refund.

Each brother controls his holdco, is related to his brother, and is treated as owning 50% of opco through his holdco. That can associate each holdco with opco (section 256(1)(d)) and the two holdcos with each other through opco (section 256(2)). If they are associated, the three companies share one business limit.

Different for you?

• You have decided and want holdco formed and the transfer done in order: get business formation help for holdco and corporate tax help for the transfer and Form T2057.
• Your opco shares are worth far more than you paid, or you want cash or a note back: the elected amount and section 84.1 need numbers before anyone signs; get corporate tax help.
• A sale or a new investor is coming: read selling your business and plan the holdco with corporate tax help before terms are agreed.
• You missed the Form T2057 deadline: a late election with a penalty may still be possible within 3 years after the deadline, and after that only at the CRA's discretion; get corporate tax help.
• Family members will own shares of holdco or opco: see share classes and family shareholders and get corporate tax help.
• You live in Quebec, or either company is in Quebec: Quebec can need its own filings for the transfer; get corporate tax help.
• You will now run two companies: each needs its own books, year-end statements and T2; see bookkeeping.
• You or a co-owner live outside Canada: section 212.1 applies instead of section 84.1, so cash or a note from holdco above the shares' paid-up capital (your cost does not count) is a deemed dividend, and holdco must withhold non-resident tax from it (section 215). If more than half of opco's share value came from Canadian real estate or resource property at any time in the last 60 months, holdco can owe tax on your behalf unless you get a section 116 certificate (section 116(5)). See non-resident owners of a Canadian corporation and non-residents selling Canadian property.
• You run a sole proprietorship, not a corporation: see moving a business into a corporation.
• You are a startup founder: see holding startup shares through a Canadian holding company.
• You are still deciding whether a holdco is worth it: see holding and investment corporations.