What is the difference between a holding company and an operating company?

An operating company is the corporation that actually conducts the business — signing contracts with clients, employing staff, generating revenue, and taking on operational liability. It is on the front lines.

A holding company (often called a "holdco") is a separate corporation that owns shares of the operating company but does not carry on active business itself. Its purpose is typically to hold assets passively — usually the shares of the operating company and, over time, retained earnings extracted from the operating company through inter-corporate dividends.

The structure works like this: your operating company earns business income and pays corporate tax on it. Instead of paying that after-tax income to you personally (triggering personal tax), you can pay a dividend from the operating company to your holding company. Dividends between connected Canadian corporations are generally received tax-free under the inter-corporate dividend rules. The holding company then holds the cash or invests it. You only pay personal tax when you ultimately draw funds from the holding company.

Separating a holding company from an operating company also provides asset protection. If the operating company faces a major lawsuit, the assets held in the holding company are behind a separate corporate wall. A lawyer can advise on whether the structure makes sense for your situation and how to maintain the separation properly.