To assure growth and sustainability, companies should place tax and governance considerations at the heart of their long-term strategic plans. Taking a strategic approach to one’s organizational framework is important to ensuring proper risk management, creating operational efficiencies and enhancing the resilience of one’s business. This is especially true from a tax perspective.
In a previous article entitled “10 Concrete Actions for Effective Board Governance and a Successful Year,” we discussed how corporate structure can be used as a lever for efficiency. We now expand on this concept by exploring the various tax and organizational strategies that can be implemented, in accordance with governance best practices, to ensure disciplined and sustainable business management. It is worth noting that, to be effective, these strategies should be aligned with the business’s objectives.
The holding company: A catalyst for performance and flexibility
When corporate governance demands both rigour and agility, holding companies are a key strategic tool. These are separate legal entities whose primary purpose is to hold equity interests in other companies, manage investments, or centralize strategic assets.
Holding companies are frequently used in tax and estate planning strategies, particularly because of the advantages they offer in terms of asset protection and income distribution, such as:
- Tax-free inter-corporate dividends. Within a corporate group, dividends paid by an operating company to a holding company are generally tax-exempt under the rules applicable to inter-corporate dividends. This allows for efficient capital retention within the group, which makes it easier to implement reinvestment or asset protection strategies.
- Asset protection. The assets held by the holding company are legally separate from those of the operating company, thus shielding them from commercial risks and potential liabilities arising from business operations.
- Other benefits. Retaining earnings within the holding company allows the company’s shareholders to decide when they wish to receive cash in the form of dividends, based on their personal tax situation and liquidity needs. It also allows the holding company to invest directly in new projects without the need for additional funding or financing.
Organizing activities into separate entities
As part of careful tax planning, separating a company’s business activities and assets into distinct legal entities is a proven strategy for risk management and tax optimization.
In the Canadian context, this structure limits the exposure of assets to commercial liability while facilitating the management of financial flows between entities.
Moreover, this structure facilitates estate planning and offers greater flexibility in the management, transfer, and reorganization of assets, notably by allowing specific components of the business to be separated in the event of transactions or changes in ownership.
Tax efficiency aligned with business objectives
To ensure tax and organizational efficiency, companies should regularly check that their operational structure still meets their needs and maximizes the various tax benefits available.
Corporate reorganization
Where necessary, the financing structure of companies should be reviewed, particularly with regard to loans taken out for acquisition purposes or to finance their own operations. In principle, interest on such loans is deductible, subject to compliance with applicable tax requirements. However, if the debtor company has no income, the deduction becomes inapplicable. In such a case, a corporate reorganization, such as a merger or liquidation, may be considered as a way to attach interest expenses to a revenue-generating entity, thus maximizing their deductibility.
The shareholding structure should also be assessed in relation to shareholders’ objectives. Suppose a sale is contemplated in the medium term (more than 24 months). In that case, it may be advisable to structure the holding so as to benefit from the lifetime capital gains exemption (LCGE), currently set at $1,250,000. This exemption requires, among other things, that the shares be held personally or by a related person for the 24 months preceding the disposition.
Discretionary family trust
In some cases, setting up a discretionary family trust may prove advantageous. This type of trust makes it possible to not only consolidate share ownership, but also multiply access to the lifetime capital gains exemption by allocating the capital gain realized on the disposition of the shares to several eligible beneficiaries, such as the shareholder’s spouse or adult children. It should also be noted that in Québec, as the trust constitutes a separate patrimony, it protects the shares against creditors of the shareholder or beneficiaries of the trust.
Establishing a family trust must be carefully planned to ensure compliance with the Income Tax Act and to avoid triggering any attribution rules or general anti-avoidance provisions.
Holding company
On the other hand, if shareholders want to hold on to their shares and continue investing in the company or in other companies, setting up a holding company may be a tax-efficient option, as previously noted. A holding company may receive tax-free dividends provided it holds more than 10% of the voting shares in the operating company. These pre-tax sums can be reinvested in other business projects.
US subsidiary to mitigate exposure to tariffs
Due to the protectionist measures adopted by the Trump administration, many Canadian companies are currently facing substantial tariffs on their exports to the United States. To remain competitive in the American market, companies often consider incorporating a subsidiary in the United States.
By establishing a US subsidiary, a Canadian company creates a separate legal entity governed by the corporate law of the US state in which it is incorporated. The subsidiary is considered a US company for customs and trade purposes, which means it can avoid tariffs on goods produced or processed locally, since they are no longer considered Canadian imports.
This strategy gives rise to various legal and tax obligations, including compliance with US tax laws, such as federal corporate income tax and reporting obligations to the US Internal Revenue Service (IRS). One should also consider the application of transfer pricing rules between the Canadian parent company and its US subsidiary. Proper documentation demonstrating compliance with these rules should be maintained to avoid tax adjustments or penalties in the event of an audit.
In addition, it is important to consult and analyze bilateral tax treaties, particularly the Canada-United States Convention with Respect to Taxes on Income and on Capital, to avoid double taxation, optimize income distribution, and ensure the compliance of cross-border operations.
Structures that facilitate business transfers
Every company should consider the different legal and tax structures available to facilitate the integration of key employees or family members into the body of shareholders, as well as the transfer of the company to the next generation. A well-structured tax reorganization can allow for the gradual entry of new shareholders while keeping control of the company in the hands of its founding shareholders.
Estate freeze
One of the mechanisms commonly used for this purpose is an estate freeze, which involves converting existing common shares into fixed-value preferred shares, thereby crystallizing the value accumulated to date. New shareholders, whether children, employees, or a family trust, can then purchase new common shares, allowing them to participate in the company’s future growth. The gradual redemption of preferred shares by the company, using its profits, can ensure that new shareholders don’t have to resort to external financing.
Incorporation for arm’s-length transfer
In the context of an arm’s-length transfer from outgoing shareholders, it may be advantageous to acquire the shares through a company incorporated for this purpose. This company can receive tax-free inter-corporate dividends, provided it holds a sufficient interest, and use those funds to finance the purchase of shares, with no immediate tax consequences.
Intergenerational transfer of eligible shares
Recent amendments to the Income Tax Act now allow, under certain conditions, the intergenerational transfer of eligible small business shares to children, nephews, or nieces, while benefiting from the lifetime capital gains exemption, thus avoiding the application of dividend recharacterization rules.
Employee ownership trust
An employee ownership trust is a new way of ensuring business continuity and retaining key talent.
Conclusion
Rather than simply reacting to economic changes, it is best to proactively adopt an organizational strategy that takes tax considerations into account. This is a crucial lever for companies seeking to strengthen resilience, optimize operations, and control risks. However, its effectiveness hinges on an analysis tailored to the specific characteristics of each company, as part of an approach aligned with governance best practices.
Take a proactive approach and explore strategies that apply to your situation. The right strategy could help you rethink—or even reinvent—your company’s growth.