Diverse and often misunderstood, holding companies play a unique role in today’s society and for many entrepreneurs they’re a critical part of any business entity.
But that doesn’t stop most people from asking the same basic question: ‘What exactly is a holding company?’
Well, they manage income and tax liabilities, reduce risk, and shield the assets of corporate structures. Their advantages are many and, coupled with formation in tax-efficient overseas jurisdictions, they offer a significant route to advance your business and wealth protection goals.
While an active business company generates income directly, a holding company is a parent company that either partially or wholly owns other companies, known as subsidiaries. A holding company can be both for passive assets and related to the business someone is operating.
A holding company deals with passive income since it relies on holding the various assets that produce passive income, such as stocks, bonds, real estate and even crypto of a corporate group. A holding company’s purpose is to control other companies and benefit from their profits, sometimes without direct involvement.
There are different kinds of holding companies:
· A pure holding company only exists as a vehicle for ownership of other companies and does not participate in any other type of business.
· A mixed holding company has its own business operation in addition to managing subsidiaries, that is, the companies that it owns and how they operate.
Pure holding companies don’t sell products or services but own other companies that do. So, holding companies exist based on the strategies and benefits they provide, like asset protection. Because they shield one company’s assets from another’s liabilities, this lets you own several other companies in a parent–child type structure.
With an operating or active business company, once you start generating a profit and have surplus cash, those funds can become passive.
Unless they are actively invested back into the business or used for investment purposes, they simply accumulate without any real purpose, especially in larger corporations. Keeping too large a value of passive assets in an active company can leave them open to higher taxes and litigation – using a holding company and transferring assets into it to create a separate legal entity offers better legal protection.
As a result, protection is probably the top reason why individuals choose to incorporate a holding company and remove their assets from the operating company. If the operating company ever needs those funds back for an expansion, a particular project or because it’s short of cash, the holding company can lend the money back to the operating company. So, any funds within the holding company remain accessible to the operating company but out of the reach of creditors.
Minimise Exposure to Risk
In unforeseen circumstances, the creditor protection a holding company provides can minimise exposure to risk. When the retained earnings from a trading company are transferred as a tax-free dividend to a holding company, its cash reserves are largely protected. This is because the holding company’s assets are only exposed to risk to the extent of its investment in the trading company.
Once the passive assets, such as cash, real estate or investments are removed from an operating company’s balance sheet, they cannot be accessed for liability purposes. In the event of bankruptcy, for example, all assets owned by the operating company can be accessed, or at least pursued, by a liquidator or creditors, but creditors can’t go after assets outside that operating company.
Holding Company Tax and Flexibility Benefits
As mentioned, holding companies can also provide tax advantages, depending on the corporation’s country of incorporation and tax residence. For example, if you own a company directly and it pays you dividends, you generally have to pay taxes on the dividend payments.
However, if your holding company owns the shares of another business, the dividends that the holding company receives are typically tax-free in certain jurisdictions.
A holding company also offers the ability to reinvest cash reserves tax-efficiently. Active business income is typically subject to corporate tax and earnings that, once taxed, are usually distributed to shareholders in the form of dividends. These dividends are also subject to personal tax when paid to individual shareholders.
Alternatively, when dividends are paid to a holding company they are tax free and can be used to reinvest in the business. Each shareholder of the trading company can use their own holding company structure to receive the dividends and decide what to do with them: leave them there, pay themselves, or reinvest them.
This flexibility is a key benefit of a holding company. If, for example, partners in a business made two million in profit, that money paid in dividends from a trading company to each person would be liable to standard, often considerable, tax rates.
If one shareholder needed the money, let’s say for personal reasons, the profit could be divided among each individual’s holding company and the shareholders could then decide whether to pay themselves a dividend. If one partner doesn’t need capital, they can leave it in the holding company to compound for a future date.
Ultimately, a company’s profits must be paid out at some time, either as a salary or a dividend. Usually, that involves paying a significant amount of tax, so another benefit of a holding company is it allows you to defer that tax.
Instead of taking the cash, by paying yourself a minimum salary and allowing the rest to accumulate in a holding company, you will pay a much lower income tax rate. This also gives you some flexibility later to fund your retirement and pay a lot less in tax than you would otherwise.
Another sensible reason to consider an offshore holding company is when you’re either buying or selling a business. If you’re buying a business, it can make sense from a tax perspective to use a holding company to make the acquisition rather than do it personally.
Similarly, when you sell your business, capital gains tax is deducted from the lump sum you receive.
However, if the company is owned by the holding company and you’re a shareholder, capital gains tax isn’t applicable because the subsidiary is not personally owned. This does, however, mean that the proceeds from the sale go to the holding company, but you’re still in control of how you realise the proceeds and can use them to reinvest or develop other ventures through the holding company.
The tax implication here will largely depend on where the company is incorporated and the tax situation in that location. For example, in the British Virgin Islands it would be 0%, whereas Malta charges 5%.
Other benefits of an offshore holding company includes:
- Allowing for the control over several companies by the manager or CEO of just one of those companies
- Diversification – having your financial assets in several baskets
- Avoiding regulator scrutiny by having a corporate structure that avoids creating a monopoly.
Lastly, and crucially, a holding company helps you have more control over your assets, whereas with a trust, the other established vehicle for asset protection purposes, you have limited control. In many cases, a holding company is the preferred option if you want higher decision-making power in managing your assets.
Why Establish an Offshore Holding Company?
Depending on the jurisdiction, establishing an offshore holding company in certain low-tax, business-friendly jurisdictions can result in low corporate taxes and exemptions on capital gains, dividends and inheritance taxes. As part of a plan to optimise your taxes, correctly planned overseas incorporation can reduce your overall tax burden.
Asset protection has become a buzzword in the offshore industry in the last couple of years, especially with the attempts of governments to introduce Central Bank Digital Currencies (CBDCs) and similar systems. As a result, more and more entrepreneurs are looking to move their businesses and assets offshore to protect them.
Some jurisdictions are suitable for protecting assets but they are not good for operating companies because you cannot access the banking you need for day-to-day operations. You can open bank accounts on the ground there but those may not necessarily give you what you need. That’s why having your holding and operating companies in different jurisdictions makes sense.
Another good reason for this approach is to avoid putting your assets and active business into one company structure. This is one of the first traps you can fall into when looking to move offshore.
One of the most frequent mistakes people make is mixing their offshore companies. Whether they are similar or completely different, with multiple businesses, the temptation is often to put them under one company structure. That could involve having one company in a low-tax jurisdiction that merges multiple businesses for tax purposes.
That, however, is not good from multiple perspectives.
For example, it becomes harder to keep track of where money is coming from and that’s problematic when you need to open better bank accounts. Most reputable banks will ask where your money is coming from and if you have multiple revenue streams, then conducting transactions and even accessing funds might be problematic.
Banks in those jurisdictions are often set up to facilitate particular types of activity, such as people parking their money and not using it on a day-to-day basis. You can still link your operating business to your holding company but it needs to be a separate corporate structure and preferably be in a different jurisdiction.
Offshore Jurisdictions for Holding Company Formation
In general, offshore jurisdictions offer significant benefits when incorporating a company, which include:
- Substantial tax benefits, reduced compliance obligations, fewer related costs and enhanced banking privacy
- Corporate law that permits the flexible creation of various company types
- Accessible options to protect wealth and assets
- Economic and political stability, sound judicial structures and corporate laws.
Some notable offshore company setup locations to start an offshore holding company in include:
Hong Kong
When going offshore, the most important decision is choosing the right place to incorporate. Hong Kong is a notable jurisdiction based on its good reputation, strong bank infrastructure and business-friendly environment.
A gateway to doing business in China, with its open trade policy and competitive economy, Hong Kong is an ideal location for entrepreneurs and investors to generate high returns. Unlike other places, it sanctions 100% proprietor ownership of foreign businesses.
The corporate tax rate in Hong Kong ranges from 8.25%-16.5% for revenues derived from within its national borders, but through its offshore profit claim, a 0% tax rate on worldwide income. With most of the world’s leading banks present there, it has a highly developed financial system.
Singapore
An offshore holding company location with a reputation for encouraging foreign startups, entrepreneurs and investors, Singapore allows for easy wealth and asset management and is also highly tax-efficient, with only businesses controlled in Singapore taxed.
With over 70 international tax treaties and a flat corporate tax rate of 17% that applies to both local and foreign companies, tax exemption schemes and catalysts for startups and investors in tech-based industries are widely available. For companies not managed and controlled in Singapore, there is a potential for 0% corporate tax.
Cayman Islands
The Cayman Islands is a British Overseas Territory in the Caribbean that enjoys an accessible location and a ready-made set-up for company incorporation.
As a 0% tax jurisdiction, Cayman Islands companies can be established as tax-exempt if they work with international clients, refrain from engaging in business on the island and have directors and shareholders who are not physically located there.
Under offshore company formation rules, the Caymans have no corporate tax, capital gains, dividends or interest tax. Another reason for incorporating there is its favourable regulations around confidentiality and privacy.
The British Virgin Island (BVI)
BVI companies are widely used as listing vehicles, both as operating and holding companies. However, BVI is the world’s most popular offshore holding structure as an effective route to creating tax-neutral layers in corporate holding structures.
The British Virgin Islands is one of the most business-friendly jurisdictions in the world and there are substantial tax benefits to setting up a company there.
Multiple types of entities can be set up there for the purpose of holding assets. They include LLCs and International Business Companies that pay no corporate tax on profits derived outside the BVI, no capital gains tax, no value-added tax (VAT) and no withholding tax. Other benefits include:
- Ease of doing business and banking
- No requirement for annual meetings
- No requirement for financial reports and annual returns.
In many ways, The British Virgin Islands is an ideal option for wealth protection and asset holding companies.
Plan Properly with Nomad Capitalist
However, wherever you decide to incorporate, you will need to plan it carefully.
That’s where Nomad Capitalist comes in.
We help seven- and eight-figure entrepreneurs and investors create a bespoke strategy using our uniquely successful methods. We’ll help you keep more money, create new wealth faster, and be protected from whatever happens in just three steps. Become a client today.
