Which Company Should Hold the Contract, and What That Changes

Two corporations in one structure produce a question a single corporation never raises. The contract can sit in the operating company, where the business is carried on, or in the holding company, where the surplus has been moved. Both placements are ordinary in Canada, both are used every day, and they produce different results on a claim, in front of a lender, and on the day a buyer opens the books. The placement is settled once and corrected expensively.

This page sets out what each placement changes. It recommends none of them, because the facts that decide it belong to a particular group with a particular history and a particular plan for the next decade. The decision belongs to the owner's CPA and the owner's lawyer or notary working together, on the real figures of both companies, before anything is signed.

What is a holding company, and why do owners create one?

A holding company is a corporation that owns shares of another company and holds assets it does not use in a trade. Owners create one to move surplus cash out of the business that generates it, to separate shareholders with different plans, and to hold real property apart from the operation.

The mechanism rests on two ordinary rules. Shares of the operating company are held by the holding company, so the holding company is the shareholder of record. Dividends paid between connected Canadian corporations generally move without immediate tax, which is what lets profit leave the business each year and settle somewhere quieter. Your CPA confirms both points on your own share register and your own filings. The second company is a corporation like any other, with its own directors, its own resolutions and its own annual return.

None of that makes a holding company correct for a given owner. It adds a second set of filings, a second minute book, a second bill from the accountant every year, and one more layer between the profit and the person who earned it. The structure is worth its cost where there is surplus to move and a reason to move it. Where the business consumes everything it earns, the second company is an expense with nothing to do.

What sits in each company in a typical structure?

In the common arrangement the operating company holds the trade: inventory, receivables, equipment, staff, contracts and the customer relationships. The holding company holds shares of the operating company, retained surplus moved up by dividend, and sometimes real property leased back down. The shareholder holds shares of the holding company.

The arrangement is usually built over time and not on the day of incorporation. An owner incorporates, trades for a decade, accumulates more than the business needs, and then a holding company is inserted above the operating company by a reorganisation. The contract issued before that reorganisation sits wherever it was placed, unchanged, while the structure moves around it. The insurer is told nothing, because nothing in the contract requires it.

Two facts about that arrangement carry the rest of this page. The operating company is where the trade risk lives, because that is where the contracts are signed, the staff are employed and the work is performed. The holding company is where the value is parked, and it has no customers, no employees and no way to be sued for a job done badly. Everything that follows is a consequence of that division. Read that division once and most of the rest of this page follows from it.

Why is the operating company the one carrying the trade risk?

Because the operating company is the party to every contract, the employer of every worker and the supplier of every job performed. A claim from a customer, a supplier, an employee or a lender lands on the company that dealt with them. The holding company is a shareholder and deals with nobody.

That is the whole reason the structure exists in the minds of most owners. Cash that stays in the operating company sits behind the trade creditors of that company, behind its lender and behind anyone who sues it. Cash paid up to the holding company as a dividend is one corporation removed from those claims. An owner who has heard the structure described will usually have heard it described in exactly those terms. The structure moves the money and it does not make the money safe.

The description is accurate and it is incomplete. Incorporation limits liability for business obligations, and it answers nothing where a personal guarantee was given, which covers most small business lending in Canada. Director liability for unremitted source deductions, for GST or HST and for unpaid wages attaches to the individuals personally. A professional who incorporates stays personally liable for their own acts. That position is stated in full on the silo pillar, and it belongs beside every sentence on this page about where an asset sits.

Where can the contract sit, and what changes in each case?

The contract can be owned by the operating company, by the holding company, or by the shareholder personally. Ownership decides who controls every election, whose balance sheet carries the accumulated value, who receives the amount payable on death, and whose creditors can reach the asset while the life insured is alive.

Where the operating company owns it, the premium comes from the company that earned the profit, the accumulated value sits on the statement a lender reads, and the amount payable arrives inside the company carrying the trade risk. Where the holding company owns it, the premium is paid from surplus that has already been moved up, the value sits away from the operation, and the amount payable arrives one corporation removed from the customers and the staff. The mechanics of ownership by a company are set out on corporate-owned life insurance.

The roles can also be split across the two companies, and that is where the trouble starts. The holding company owns the contract while the operating company pays the premium. The operating company owns it and the holding company is named as beneficiary. Each of those has a version an accountant will sign off on and a version that produces an assessment, and telling them apart is work done on the actual facts of the two companies. The insurer issues what the application asks for and asks none of these questions.

What if the owner, the payer and the beneficiary are different companies?

A mismatch among the three is the commonest expensive error in a two company file. Where one corporation pays a premium on a contract another owns, the Canada Revenue Agency can treat the payment as a benefit conferred on a shareholder under Income Tax Act s.15(1), and the assessment usually arrives years later.

The version owners build without thinking is the operating company paying for a contract the holding company owns. It feels right, because the operating company is where the cash is generated and the holding company is where the assets are kept. What has happened on paper is that one corporation has funded an asset belonging to another, and the benefit of that funding has to land somewhere the tax system recognises. Some arrangements survive that question and some do not. The question is never whether the payment happened, since the cheque proves that much.

The timing is what makes it costly. A benefit under s.15(1) does not announce itself in the year it arises, and it surfaces on an audit or during the diligence on a sale, covering several years at once. Correcting it by moving the contract is itself a disposition, measured against the adjusted cost basis, so the correction carries a second cost. Settle owner, payer and beneficiary in writing with your CPA before the application is signed.

Which company receives the credit to the capital dividend account?

The one that receives the amount payable on death. Where a corporation receives a life insurance death benefit, the excess over the policy's adjusted cost basis is credited to that corporation's capital dividend account under Income Tax Act s.89(1), and the account belongs to that corporation alone.

That single fact decides the route the money takes. If the operating company is the beneficiary, the credit arises there, and a capital dividend paid from that account goes to the shareholder of the operating company, which in this structure is the holding company. A second dividend is then needed to move the money from the holding company to the person. If the holding company is the beneficiary, the credit arises one step closer to the shareholder and one dividend does the work. Two dividends and one dividend are not the same plan, and the difference shows up in the hands of the family.

Three qualifications belong with the credit every time it is stated. It is the excess over the adjusted cost basis and never the whole amount payable, and that basis moves across the life of a contract. The election is a filing that has to be made correctly and on time. And the account is notional and shared, because other corporate transactions add to it and subtract from it across the company's history. Have your CPA calculate the expected credit under s.89(1) on your own projected figures before any of this becomes a reason to place the contract anywhere.

Does moving the contract to the holding company protect it from creditors?

No page can tell you that. Moving an asset out of the operating company changes who can reach it in the ordinary course of business, and it promises nothing. A transfer made when a claim is already in sight is reviewable, and a personal guarantee travels with the person who signed it.

The mechanism is real and its limits are equally real. An asset held by the holding company is not an asset of the operating company, so a trade creditor of the operating company has no direct claim against it. Provincial and federal law allow transfers made to defeat creditors to be reviewed and set aside, and that review looks at what was known and when. A structure built years before any dispute stands differently from one built the month a statement of claim was served, and which one you have is a question for a lawyer or a notary on your own facts. The word doing the work in that sentence is reviewable.

Two things travel with the person and never with the company. A personal guarantee given to a lender or a landlord follows the individual who signed it into every structure they build afterwards. Director liability for source deductions, for sales tax and for unpaid wages attaches to the individuals who serve as directors. Nothing on this page establishes that any particular asset is beyond the reach of any particular creditor, and nobody should read it that way.

What does a lender do when the value sits in the holding company?

A lender reads the statements of the company it is lending to. Where surplus has been moved up, the operating company presents a thinner balance sheet, and the lender responds by asking for a guarantee from the holding company, a guarantee from the shareholder, consolidated statements, or all three.

The effect is easy to miss because it arrives as paperwork. An owner who has spent a decade moving surplus into the holding company arrives at a renewal and finds the credit facility now depends on a guarantee reaching back into the structure the surplus was moved to. The lender has done nothing unusual. It has priced the risk it can see and secured what it can reach. Lenders read structures for a living.

Where the contract sits inside all of this is a small question with a practical edge. A contract held by a company and carrying accumulated value is an asset a lender will notice, and some lenders will ask for it to be assigned as security. An assignment is registered against the policy and restricts what the owner can do with the value while the loan runs. Establish which company gives which guarantee, and what is assigned to whom, before the facility is signed.

What happens to the placement when the company is sold?

Two tests look at the same balance sheet from different directions. The lifetime capital gains deduction at Income Tax Act s.110.6 applies to qualifying small business corporation shares, and qualification depends on the proportion of assets used in an active business, measured over a period before the sale.

This is the argument most often given for placing the contract in the holding company. Accumulated value inside the operating company counts on the wrong side of that measurement, and a purifying transaction moves non-active assets up to the holding company so the shares of the operating company can qualify. The contract is one of the assets that gets moved, and moving it is a disposition measured against the adjusted cost basis. A purification planned two years ahead costs a fraction of the same exercise attempted in the weeks before a closing. That planning is an accountant's file and it opens years before a buyer appears.

The qualification test also looks at the holding company, which is the part owners skip. Where the shares being sold are shares of the holding company, the assets of the whole group come into the measurement, and a holding company full of passive value is the problem the purification was meant to solve. Which shares are being sold decides everything here, and the answer differs for a share sale, an asset sale and a wind up. Test qualification periodically with a CPA who holds the real figures of the group.

What if a family trust or two families hold the shares?

Then a premium paid by one company can benefit a shareholder who owns no part of the other, and that is the clearest version of the problem under s.15(1). A family trust holding the shares adds beneficiaries whose interests are not identical, and the trust deed decides what the trustees may agree to.

Structures where the two companies have different shareholders are ordinary. A shareholder who wants a separate holding company gets one, so a business with three owners can sit under three holding companies with three families behind them. Once that is true, a premium paid by the operating company on a contract owned by one of those holding companies has moved value from a pool three families own into a pool one family owns. Three families with one operating company between them is a common Canadian arrangement, and it is rarely documented as carefully as it was built. That is a shareholders agreement question before it is a tax question.

A family trust adds a further layer, because the trustees owe duties to every beneficiary and the deed limits what they may do. A trustee agreeing that trust property should fund a premium on a contract benefiting one beneficiary has a decision to record and a reason to record it. A trust also faces a deemed disposition of its property on a fixed anniversary, which moves on its own calendar. Your lawyer or your notary reads the deed and your CPA prices the consequences, and neither of those two jobs belongs to an insurance advisor.

What has to be documented before the first premium is paid?

Four things, in writing, and each is short. Which company owns the contract, which pays the premium, which is named as beneficiary, and why the arrangement creates no benefit under s.15(1). A note answering those four and travelling with the policy will still be legible when nobody who signed it is available.

Three further documents belong in the same folder. An intercompany agreement, where one company pays for something the other owns, stating what is paid, on what terms, and what happens if the payments stop. A record of any consideration passing between the companies, because a payment supported by consideration and a payment supported by nothing are read differently. And a note of how the capital dividend account credit under s.89(1) is expected to be calculated, on the projected adjusted cost basis. Each document is short and each is far cheaper than the conversation it prevents.

The reason all of this matters is that the reader of the file will not be you. It will be an auditor, a buyer's counsel, or your own professionals years after the people who built the structure have moved on, and the file has to explain itself with nobody present to explain it. The framework for an incorporated owner, including what a corporation does not fix, is set out across the business owners section. This practice holds an insurance licence and gives no tax advice and no legal advice.

Who this suits, and who it does not

This page suits an incorporated owner who already has two companies, or who has been advised to create the second one, and who holds a contract or is considering one. It suits the owner whose structure was reorganised after a policy was issued and who has never checked whether the arrangement still matches. It applies with most force where a sale of the shares is possible within ten years.

It applies with less force to an owner with a single company and no surplus worth moving anywhere, because the placement question sits downstream of whether a second company earns its cost. It applies with less force again where the coverage is small and temporary, since the accumulated value that drives most of this analysis barely exists in a term life insurance contract. Those owners can settle the coverage question first and come back to this page later.

It does not suit a reader who came for a rule about creditors. No such rule exists here. Participating whole life insurance is an insurance product and it is not an investment, and the placement question turns on facts this page does not have: your two balance sheets, your guarantees, your province, your horizon, and what your own professionals conclude when they look at the two companies together.

Answer the question underneath the placement before you answer the placement itself. Which company is the money for, and who has to receive it at the end. An owner who can answer both can evaluate any structure put in front of them, and an owner who cannot will end up with whichever structure the paperwork defaulted to.