This month’s blog post was co-written by Héléna Gagné, Partner, and Marc Roy, Associate, at Osler, Hoskin & Harcourt LLP.

There are a number of reasons why one may use a personal holding corporation as a part of her or his estate planning. In particular, it may have received tax-free intercorporate dividends from an operating company which were used to acquire investments in the holding company and benefitting from a deferral of the tax that would have otherwise been payable on those dividends had they been paid to an individual instead of the holding company. It may also be that an individual has transferred assets or investments to a holding company and introduced a family trust as part of a plan to pass property to one’s children while minimizing tax on death by deferring the realization of capital gains to the next generation.

In addition to these deferral advantages, using a holding company may be useful when it comes to making charitable donations in light of the recent changes to the alternative minimum tax (AMT). Under the new AMT rules, only 50% of the donation tax credit for charitable gifts made by individuals is allowed when determining whether the AMT applies and, depending on all the circumstances, can result in significant tax owing despite making a large charitable gift. The AMT does not apply to corporations and making charitable gifts from a holding corporation remains an effective strategy to support important causes in a tax-efficient manner.

There are, however, certain downsides that are important to be aware of. In our Canadian tax system, we have a general principle referred to as “integration” pursuant to which the total amount of tax paid at the corporate level and at the personal level on corporate income distributed to an individual shareholder should come out to the same amount as if the income was earned directly by the individual. However, this principle does not always work out perfectly; when it comes to capital gains earned by a holding corporation, in particular, the total amount of tax that has to be paid is slightly greater than if the capital gain is realized directly by an individual.

A much more important potential downside, but one that can be avoided with proper planning, is the potential for double or even triple tax upon death.

Generally, on a person’s death, there is a deemed disposition of their capital property and realization of any latent capital gains, giving rise to tax on those gains. But there can also be tax at the corporate level (e.g., upon a sale of assets by the corporation), and on the windup of the corporation or on distribution of its assets to an individual who inherits the shares.

Consider a parent who owns the shares of a holding company with investments that have appreciated in value, and who leaves those holding company shares to his or her child in his or her will.

If the parent simply held the investments personally, on death the parent would realize a capital gain on the appreciated value of the investments, which would be subject to tax in the estate in respect of the parent’s final taxation year. The child would inherit the investments with full basis and would only be taxed in the future on any further gains.

With the investments held in a holding company, on the other hand:

• The parent’s estate pays tax on the capital gain in respect of the holding company shares;
• When the holding company sells the investments to distribute their value, it realizes another capital gain and pays tax at the corporate level, effectively taxing the same gain twice;
• If the holding company also makes distributions to the child, the child pays tax on the taxable portion of the dividend received.
• The child will have capital losses in respect of the holding company shares, but the use of those losses is limited and insufficient to offset the additional tax.

This negative outcome can be prevented with good post-mortem planning, but the post-mortem planning can only be executed with good planning during life in anticipation. In particular, it is important to give the flexibility in your will to your executors to proceed with reorganizations of your holdings. The legal structure of your holdings might also be arranged prior to death in accordance with your estate planning goals with an eye to avoiding any tax pitfalls.

Another common situation that is important to plan for is the possibility of cross-border heirs to your estate. Making distributions to a beneficiary in the U.S. or other countries can add numerous layers of complexity. Where a U.S. beneficiary stands to inherit shares of a Canadian holding company, different strategies may be applied before death to prepare and to minimize the risk of double taxation between Canada and the U.S. 

Cidel’s team of professionals can assist you in assessing all of your planning needs and can refer you to appropriate tax specialists to address and mitigate these and other potential pitfalls. It is important to involve and coordinate between your lawyer, accountant, tax specialist and wealth management team, who may play the role of chef d’orchestre, and always ensuring a holistic approach to your entire situation and your potential tax concerns.

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