Holding Company vs. Trust

I am often asked by my automobile dealer clients whether it makes sense to introduce a holding company or family trust into the corporate ownership structure for creditor proofing and/or estate planning purposes. When a person decides to start a new business and incorporates, there is often a level of uncertainty as to whether the new venture will be successful, thus cost control is often paramount.

Most people opt to keep their corporate structure simple (meaning they don’t want to spend money on lawyers and accountants to set-up holding companies and trusts), which is understandable. However, if you have the resources upon incorporation, you should consider having a family trust own the shares of the private corporation from the outset rather than directly owning the shares.

Two reasons to consider this corporate structure are as follows:

1. A holding company can provide similar benefits to a direct holding company but with less risk.
2. A family trust provides the ultimate in tax planning flexibility.

Assuming your corporation is an active company, not an investment company, there are several benefits to having a family trust as a shareholder of your private company.

Multiply the Lifetime Capital Gains Exemption

If the company is eventually sold, a family trust potentially provides for the multiplication of the $750,000 lifetime capital gains exemption on a sale of qualifying small business corporation shares. That is, it may be possible to allocate the capital gain upon sale to, your spouse, children, yourself or other beneficiaries, which means substantial income tax savings. For example: where there are four individual beneficiaries of a family trust, the family unit may be able to save as much as $700,000 in income tax if a corporation is sold for $3,000,000 or more.

Family Trust Can Receive Dividends

In addition, where your children are 18 years of age or over, the family trust can receive dividends from the family business and allocate some or all of the dividends to the children. The dividends must be reported in the tax return of the child, but in many cases, the dividends are subject to little or no tax (if a child has no other income, you can allocate almost $40,000 in dividends income tax-free).

Creditor Proof Earnings

Finally, where you have surplus earnings in a corporation and wish to creditor proof them but don’t want to allocate the funds to your spouse or your children, you may be able to allocate those funds tax-free to the holding company if it is a beneficiary of the trust. This allows for an income tax deferral of personal taxes until the holding company pays a dividend to its shareholders.

Why would I ever not choose a family trust? Some of the reasons are as follows:

1. The initial accounting and legal costs may be as high as $7,000 - $10,000.
2. You may not have children or, if you do have children, they are young and you cannot allocate them dividends without the dividends being subject to the “Kiddie Tax” (a punitive income tax applied when minors receive dividends of private companies directly or through a trust).
3. You are not comfortable with allocating to your children any capital gains from a sale of the business and/or any dividends since legally that money would belong to them.
4. If the business fails, it may be problematic to claim an Allowable Business Investment Loss (a loss that can be deducted against any source of income) that would otherwise be available if the shares of the company were held directly by an individual.
5. There are some income tax traps beyond the scope of this blog post when a holding company is a beneficiary.

As discussed in the opening paragraph, once a business is established and has become successful, a holding company can still easily be introduced as a shareholder and the transaction can take place on a tax-free basis. A holding company is also often problematic, as the level of cash the holding company holds can put it offside of the rules for claiming the $750,000 lifetime capital gains exemption if the business is sold in the future. Thus, you may wish to consider utilizing a family trust, unless you do not have children or do not anticipate being able to sell the corporation.

If one waits until the business is successful to introduce a family trust, as opposed to introducing one as an original shareholder when the business is first incorporated, the value of the business as at the date of the reorganization must first be attributed to the original owner(s) utilizing special shares (typically referred to as an estate freeze). The costs of introducing a family trust with a holding company beneficiary as part of an estate freeze could be as high as $15,000 -$20,000 as a business valuation is often required.

The Takeaways

This issue is very complex. The key takeaway should be that having a holding company as a direct shareholder of an operating company may not always be the most tax efficient decision. A family trust with a holding company beneficiary may be a more appropriate choice depending on your circumstances.

In any event, you should definitely consult a professional advisor before undertaking such planning in order to understand the issues related to your specific situation and ensure that you are not breaching any hidden income tax traps. 

-- Jeff Carbell

Succession Planning

Why do automobile dealer owners find it so hard to sit down and plan for their succession? 

According to a survey conducted by a national accounting firm, only one-third of family owned businesses survive the transition to the second generation. And of these businesses, only one-third survive to the third generation. Pretty poor odds for your grandchildren taking over the family business.

There are three basic reasons why succession planning fails.

Procrastination
Like many business owners, automobile dealer owners are often too busy, too tired, too whatever excuse to sit down and plan for the transfer of the family business. In fact, it is my experience that most automobile dealer owners wait too long resulting in either a fire sale at the last minute or selling to an unintended third party. Or worse, chaos ensues due to illness or even death with no succession plan in place.

Lack of Successors

The second reason for unsuccessful succession transitions is the lack of qualified successors. Automobile dealer owners are notorious hoarders when it comes to delegating and hence grooming a successor. The reins are kept so tight that no one is identified early on and therefore nobody is ready to take over, or worse, the most qualified people leave the business due to frustration.

Poor Planning

The third reason for unsuccessful business transitions is due either to the failure of the business or poor planning. Just ask one of the unfortunate General Motors automobile dealers what they would have done differently if they could do it all over again. Their answers would by unanimous. Much better and earlier planning!

Creating a Successful Plan 

The key to a successful transition plan is taking the time to sit down and plan for succession. What should be my succession plan? Should I sell to my general manager or my children? Maybe my plan will be to run the dealership as long as I am physically able to do so and then sell. There are no hard and fast correct answers, but clearly the plan that involves leaving all planning to the end may result in insufficient or unexpected results when the dealership is sold. Planning early on for succession that involves either family members or qualified employees could achieve a better financial result.

First identify if there is a suitable candidate within your organization. Are any family members interested? If so, are they suitable and or qualified? If they need more time and experience, are you providing the leadership and opportunity for your children to succeed?

If no family members are interested you should review the talent you have within your organization. The best candidates are not always the ones that are constantly knocking on your door and driving you crazy for a “piece of the pie.” Consider hiring a human resource consultant to assist you in evaluating the potential of the candidates that you have selected.

Buying into the plan is the next important step down the road of successful business succession. Letting go is the hardest thing that a business owner faces when considering succession. I often hear clients say things like “I’m only 45 years old and not ready to retire yet and if I bring someone into the business that will certainly hasten my retirement.” No plan is perfect and your plan may need periodic tweaking to ensure that it meets or fulfills all of your succession objectives.

There are no rules as to when or at what age a succession plan should be considered and planned. My personal experience is that when automobile owners approach the age of 55 they appear to be ready to consider succession. Every individual’s situation is different and the succession plan must be customized to each owner’s unique needs.

Establishing a timetable for the succession process is very important. Critical dates to consider are:

• When you are considering retiring,
• Timing of selling the share ownership of the business. 

There are many planning techniques that could provide you with control over the dealership after you have sold your equity interest.

The next blog, to be posted the week of August 29th, will deal with the income tax considerations when contemplating a succession plan.

-- Jeff Carbell