A holding company is a separate legal entity whose purpose is to hold some sort of property, be it land, buildings, marketable securities or private stock.
In a basic holding company strategy, the holding company owns the shares of your operating company as a means of effective tax planning while protecting your wealth.
For example, suppose you are an IT consultant earning 150K per year. Given you need only 50K of cash to live on in a year, you incorporate your business to take advantage of tax deferral. Once the corporation is set up, you are then the sole owner and decide to leave any money you don’t spend within the company.
Fast forward 10 years later, you’ve developed quite a successful company with 5 employees and 1M of sales. Throughout the years you’ve only taken out from the company what you needed to live and left the remaining amount of cash in a GIC which the company owns. One day you receive a fancy legal letter claiming 1M in damages when one of your employees screws up on a software implementation. If the law suit is successful, all that hard earned cash that you’ve left within the company could be up for grabs.
Now imagine 10 years ago instead of setting up only one corporation in which you are the sole shareholder, you set up two: Holdco and Opco.
Opco is your IT consulting company, Holdco is the company which owns Opco, and you are the sole shareholder of Holdco. Instead of leaving the cash you don’t need within Opco, you transfer the ownership of that cash to Holdco by way of a dividend. Since dividends between Canadian controlled private corporations are tax-free, you now have successfully transferred your cash out of Opco to the Holdco with no negative tax consequences. If Opco is sued or faced with a liability, you can rightfully say it doesn’t have any money as the cash belongs to Holdco.
To achieve the same result without Holdco, you would have had to take out the full amount of cash sitting in your business each year personally - paying tax at the highest rate and eliminating any tax benefits of the corporation.
While the holding company setup doesn't offer 100% protection, it does offer one layer against similar situations.
It all depends what your goals are. Generally speaking, if you plan to leave the majority of your cash and investments within your corporation for many years, it may be a good idea to explore a holding company strategy. On the flip side, by setting up a holding company you may forfeit your lifetime capital gains deduction and face higher professional fees. As there are a number of both legal and tax considerations to take into account, it’s a good idea to talk to a professional before setting up a holding company.