Understanding Personal Holding Companies

Christopher Bowlby - Dec 15, 2022
Owning an investment portfolio through a personal holding company can provide various tax and non-tax benefits, but can also introduce many other tax considerations that are not applicable when investments are held personally.

A Personal Holding Company, is a corporation which holds assets; typically income generating investment assets. A Personal Holding Company is usually a Canadian Controlled Private Corporate and is a separate
legal entity from its owners, requiring financial statements and separate filing of corporate tax returns. Quite often, family members will hold the various common and preferred shares of the private corporation, and the PHC owns the underlying investment securities.

 

Uses for Personal Holding Companies

There are many scenarios where a Personal Holding Company can be utilized for both wealth planning:

Existing Business Owners: A typical strategy for business owners is to set up a PHC to hold shares of the operating company and/or to protect investment assets that are not needed in the company's business. This can be beneficial for liability protection and purifying the operating company to qualify for the Lifetime Capital Gains Exemption. Additionally, the operating company may be able to issue an inter-corporate dividend tax-free to the personal holding company and thereby allow the business owner to defer taxation inside the corporation until the funds are needed.

Former Business Owners: When a business is sold, typically a PHC is created to keep the proceeds of the sale inside a corporate entity. By keeping assets sheltered inside a PHC, the business owner will be able invest the funds and defer personal tax until wind up of the PHC or distributions in a tax-efficient manner to fund their lifestyle.

Estate Freeze/Income-Splitting: A PHC can be used to facilitate an estate freeze. An estate freeze can be a power tax planning and wealth transfer tool when formulating an estate plan. My moving appreciating assets into a PHC, the owner will be able to retain the preferred shares and cap their tax liability and transfer taxation of future growth to common share holders, typically younger family members.

 

Additional Considerations

With a PHC, there are additional considerations that factor into the decision on whether it makes sense for you and your family. With a PHC, there is additional set-up and ongoing costs; such as costs to prepare annual financial statements, corporate tax returns and maintain corporate registers. By adding an additional level of tax on the corporate level, there is the potential for double taxation and distribution of corporate assets to shareholders is more complicated and may incur both corporate and personal taxes. Finally, there are potential negative tax ramifications stemming from the PHC being a separate legal entity from the shareholder. This is most common with the use of corporate funds to pay personal expenses, or the creation of shareholder loans from the PHC to the shareholders.

 

Distributions from a PHC

There are multiple ways for funds to flow from the PHC to shareholders which can be used to distribute funds.

Repayment of Shareholder Loan: A loan to the PHC from a shareholder can be returned to the shareholder without tax consequences, since the loan was originally contributed to the corporation out of the shareholder’s after-tax funds.

Paid-Up Capital Reduction: Paid-Up Capital generally represents an amount originally contributed by the shareholder for the shares of the PHC they own. Because these amounts were originally
contributed out of the shareholder’s after-tax funds, the balance of the tax PUC can generally be returned tax-free on a PUC reduction or share redemption.

Capital Dividend Account: The CDA represents the cumulative non-taxable portion of net capital gains/losses and certain other amounts (such as life insurance proceeds) received by a corporation. Distribution of the CDA allows for the tax-free flow-through of certain amounts that would be non-taxable if the shareholder had received them directly.

Taxable Dividends: The payment of a taxable dividend by a PHC to its shareholder(s) may cause a refund of corporate tax to the PHC accumulated in the Refundable Dividend Tax on Hand notional tax accounts.

Insurance: By purchasing permanent life insurance inside the PHC and using corporate funds to pay for the premiums, shareholders are able to take advantage of the tax-deferred growth of the insurance,
and potential use of a Capital Dividend Account in the PHC at death to facilitate a tax-efficient distribution of the corporate assets to beneficiaries.

 

There are many benefits of a Personal Holding Company, especially for business owners and incorporated professionals. While Personal Holding Companies increase complexity, the benefits can makes sense for both tax and non-tax purposes and increase your wealth. By working with your tax professional, we are able to create a strategy for how to incorporate a Personal Holding Company into your wealth plan.