Asset protection and tax planning are two of the most difficult challenges faced by business owners. With tax goalposts continually shifting, and the constant threat of global uncertainty affecting business, mastering these aspects is difficult enough when you own and operate a single company. Imagine, then, how tricky things can get when you own several enterprises.
If this is the case, then setting up a holding company could be a wise decision. Also called an "umbrella company", or a "parent company", a holding company is an entity designed to manage subsidiaries more easily.
Perhaps the most famous example of a successful holding company is Berkshire Hathaway, the multinational conglomerate owned by Warren Buffett. Before you decide to follow in the paths of the Oracle of Omaha, though, there are several points that you need to consider.
Do You Really Need a Holding Company?
If you own multiple businesses, that does not automatically mean that you need to create a holding company. The crucial factors are the size of your enterprises, and more importantly, the value of the assets you hold.
A holding company can be a sensible choice if you have valuable business assets that you want to shield from any liability that may arise. These assets could be anything from shares, stocks, bonds, securities, mutual funds, and real estate, or even intellectual property, such as patents.
If your enterprises are on the smaller end of the spectrum, and your assets are not that critical, it might be better to leave things as they are. Alternatively, you could even form a single Limited Liability Company (LLC) and convert your businesses into different departments of the new corporation.
Which Type of Holding Company?
Holding companies broadly fall into two categories - corporations and LLCs. Which one you select will depend on several factors, chief among which is the main reason for creating a holding company.
If you are a small entrepreneur whose primary focus is on asset protection and limitation of liability, then an LLC is the best option for you. They are much easier to create and have fewer compliance issues as well.
However, a vast majority of holding companies created at the enterprise level tend to be corporations. They are ideal if your focus is on a tidy reorganisation of your assets and businesses concerns, or if you want to create a more efficient tax planning and financing structure.
On the downside, setting up such a corporation requires a lot of paperwork and financial resources. Governments across the world are becoming increasingly stricter when it comes to regulating corporations, too - especially those that function solely as holding companies.
Holding Companies as an Asset Protection Strategy
It should be noted that holding companies do not totally remove the liability on your assets. Liability, in most cases, is tied to the extent to which the holding company wields control over that particular subsidiary. If your holding company has X amount of unpaid shareholdings in a subsidiary, that subsidiary's creditors can only lay claim up to the X.
Assets held by other companies under the parent company will not be affected; this is one of the critical advantages of a holding company. However, it can be voided if you fail to adhere to the relevant government or regulatory body-prescribed procedures.
To this end, there are clear specified boundaries concerning what constitutes lawful restructuring of your businesses, and what constitutes an attempt to "hide" your assets from your business creditors.
All transfer of assets from subsidiaries to holding companies must be accompanied by full documentation, too. Lack of adequate records, illegal activities, and blatant undercapitalisation can all be construed as fraudulent activity by the courts.
Therefore, for maximum protection, most experts recommend that you create not one, but two companies - one for asset protection, and another exclusively for operating your businesses. The holding company should never be used for commercial activities, nor should it ideally have any dealings with third-party companies.
The Importance of Tax Jurisdiction and Planning
Holding companies are incredibly mobile, in the sense that you can set them up outside your home jurisdiction, in other states or even across international boundaries. As a result, they can have a significant impact on the tax liability of your business.
However, they can also draw unwanted attention from tax authorities. Tax laws can vary widely across jurisdictions; some regions have a high corporate tax rate, while others are minute. It is essential to consult a local tax expert before setting up a holding company overseas.
You should also pay particular attention to tax rates on incoming payments, revenues, profits, royalties, and capital gains from subsidiaries. This is where tax treaties between nations come into play, as they can allow you to avoid double taxation when you form your holding company in an overseas jurisdiction.
Since the Panama Papers scandal, most tax authorities have anti-avoidance measures in place to minimise tax evasion using holding companies, too. If you intend to create a holding company in another jurisdiction, you may be asked to prove a valid commercial reason for placing your holding company in that particular market.
How to Set Up a Holding Company
Financial authorities within each jurisdiction have their own definitions and rules regarding holding companies; therefore, it would be impossible to catalogue every law and add them here. It is possible, though, to enumerate some of the basic steps involved in creating a holding company:
- Identify how you want your business to be structured and the type of assets you plan to hold.
- Head to the website of (or request information from) your relevant local authority, research the interview process, and fill out any initial forms.
- Collect and collate all relevant paperwork, including the articles of incorporation for your businesses, subsidiaries and umbrella companies.
- Create and maintain separate bank accounts for your holding company and your operating company.
Once you have completed all the appropriate regulatory steps, you can start funding your holding company and control the flow of cash as necessary.
Setting up a holding company is not a decision to be taken lightly. The potential tax benefits are enormous - but so are the challenges involved. The content provided here is strictly for information purposes; it cannot be taken as a substitute for expert guidance. If you are seriously considering the creation of a holding company, make sure to consult local law and taxation experts if your area.
What else should business owners know about holding companies? Offer your insight in the comment section below!