Two Companies, One Cash Register: Fixing Intercompany Flows

The situation

Diego, Valentina and Ari built their business the way a lot of small companies get built: quickly, and around whatever worked at the time. Diego kept his part-time work as an early childhood educator through the first two years while the company found its footing. Valentina drove transit shifts on the side. Ari handled the books. When their accountant suggested splitting the business into two corporations — an operating company that ran the day-to-day trade, and a holding company that owned the operating company's shares and held the accumulating profits — the three of them agreed it made sense for liability protection and future tax planning. They incorporated the holding company, issued shares, and moved on to running the business.

What nobody set up was a system for how money would actually move between the two companies. Over roughly three years, the operating company had periodically transferred funds to the holding company, and the holding company had periodically transferred funds back, mostly whenever cash was tight in one company and available in the other. There were no management services agreements describing what one company was paying the other for. There were no board or shareholder resolutions declaring the transfers as dividends. There was no promissory note, no interest rate, and no repayment schedule for what functioned, in practice, as a loan running back and forth between the two corporations. The company's revenue had grown to roughly $680,000, and the informal system that worked when the numbers were small was no longer defensible.

What the review found

The team came to Treadstone Law after their accountant flagged the structure during year-end planning and recommended they get the paperwork sorted before it became a bigger problem. A review of the corporate minute book and the intercompany transfers turned up two separate issues.

• No agreements behind the money. Several transfers from the operating company to the holding company looked, functionally, like management fees — payment for administrative and strategic work the three shareholders performed through the holding company. But without a written management services agreement setting out the services provided and a reasonable basis for the fee, the payments had no legal footing. If challenged, there was nothing showing why the operating company owed the holding company anything at all.
• An overdue shareholder loan. More seriously, one transfer from the holding company to the operating company — and from there, indirectly, to Diego personally to cover a personal shortfall — had been outstanding for longer than the law allows. Under the Income Tax Act, a loan from a corporation to its shareholder that is not repaid within the required window is treated as taxable income to the shareholder in the year the loan was made, not the year it is eventually repaid. The loan in question, roughly $85,000, had crossed that window nearly a year earlier. It had never been formally documented as a loan, never carried interest, and had not been repaid on any schedule — all of which made it look, to a reviewing eye, exactly like the kind of shareholder benefit the rule exists to catch.

The first issue was fixable prospectively. The second one already had a fixed date attached to it, and no amount of paperwork drafted today could move that date.

What we did

1. Mapped every transfer of the past three years. We worked from the companies' bank records and general ledgers to build a full picture of what had moved between the two corporations, when, and in which direction — separating genuine dividend-like distributions from what was really an informal loan.
2. Drafted a management services agreement. The holding company's role — providing strategic, administrative and back-office support to the operating company — was written down for the first time, with a fee structure tied to a reasonable estimate of the value of that work, so future management fee payments would have a proper contractual basis and a defensible position if ever reviewed.
3. Put dividend declarations on paper. Past distributions that were genuinely dividends, not loans, were regularized with shareholder resolutions dated to reflect when the board had, in substance, decided to make them, and a process was set up for every future dividend to be documented the same way before the money moves.
4. Documented the outstanding balance as a formal loan. For the portion of the intercompany balance that was a genuine loan going forward, we prepared a promissory note between the two corporations with a stated interest rate and a repayment schedule, so it would no longer sit as an undocumented, informal advance.
5. Delivered the hard news on the overdue balance. We explained to Diego, Valentina and Ari that the $85,000 balance that had already crossed the repayment window could not be fixed retroactively — no agreement signed today changes when a loan was actually made. We worked with their accountant to have that amount reported as a taxable benefit to Diego for the correct prior tax year, with interest and any penalty addressed directly with the tax authority rather than left to surface later in an audit.
6. Updated the minute books for both companies. Corporate records for the operating company and the holding company were brought current, with resolutions, the management services agreement, and the promissory note all filed where a future reviewer — an accountant, a lender, or a buyer during due diligence — would expect to find them.

The outcome

The team ended up with a structure that could withstand scrutiny going forward — clean management fee flows, documented dividends, and a properly papered loan with real repayment terms. That part was a clear win. But it did not erase the cost of the earlier informality. Diego had to report the $85,000 loan as taxable income for the year it was actually advanced, which meant an amended personal tax filing, interest on the balance owing, and a bill neither he nor his co-founders had budgeted for. The three of them absorbed that cost as the price of fixing something that should have been set up correctly from the start, rather than risking a much larger and more disruptive reassessment if the informal pattern had continued or been caught later in a full audit.

Ari, who had been quietly worried about the arrangement for months, said afterward that having a clear answer — even an expensive one — was better than the uncertainty of not knowing how bad it might eventually get. The company now runs its intercompany flows on a documented, repeatable basis, and the founders review the minute book with their accountant once a year to make sure it stays that way.

The three of them also came away with something less tangible than a corrected balance sheet: a shared understanding of what each company actually did for the other. Writing the management services agreement forced a real conversation about who was doing strategic work through the holding company versus operational work through the operating company — a distinction that had blurred over three years of moving fast. That clarity turned out to matter almost as much as the paperwork itself, because it gave the three co-founders a common reference point the next time a disagreement arose about who should be paid what, and by which company.

What you can learn from this