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2017 Federal Budget Signals Tax Policy Changes Ahead

17/04/2017


​​​​​​On March 22, the Honourable Bill Morneau, Minister of Finance, delivered the Liberal government’s second Federal Budget, Building a Strong Middle Class.

The 2017 Budget contains no new corporate tax rate changes and few significant tax changes affecting dentists. However, there could be substantive changes coming later this year that would affect professionals such as dentists. 

The government has said it wants to ensure corporations contributing to job creation and economic growth continue to benefit from a highly competitive tax regime. At the same time, the government stated it’s reviewing the use of various tax planning strategies by private corporations to reduce or defer the personal taxes of high-income earners. 

Private Corporations

In the coming weeks or months, the government will issue a paper outlining policy guidelines to address how private corporations are being used for tax planning purposes.

It’s expected the government paper will address three types of strategies:

  • Sprinkling dividends using private corporations;
  • Holding a passive investment portfolio inside a private corporation, and;
  • Converting private corporate regular income into capital gains.

Depending on the study’s conclusions, there could be significant changes coming.

Sprinkling Dividend Income

Sprinkling dividend income from a private corporation is a routine strategy employed by dentists, who may have family members as shareholders in their professional corporation.

In those provinces where professionals are allowed to use family trusts, any changes that are made could impact how beneficiaries of family trusts are taxed.

It has not been uncommon for dentists to switch to taking dividends as compensation, rather than drawing a salary. Changes to the taxation of dividends and the accumulation of investment assets in a private corporation could lead dentists to increasingly prefer to take compensation as a salary instead of as dividends.

If the accumulation of assets for passive investing were to end up being taxed at a much higher rate, it would make it more difficult to accumulate assets for the purposes of investment and retirement. It could lead professionals to consider other alternatives for accumulating assets as a means of saving for retirement - such as RRSPs and individual pension plans, for example.

New Definition of Factual Control

The factual control test is used for the purposes of determining if two Canadian-controlled private corporations (CCPCs) are associated and must share a single Small Business Deduction.  Factual control of a corporation exists where a person has “directly or indirectly in any manner whatever” influence that, if exercised, would result in a control in fact of the corporation.

Consideration of all relevant factors is required in determining whether there is factual control of a corporation. A recent court decision held that in order for a factor to be considered in determining whether factual control exists, it must include “a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability.” Budget 2017 proposes the Income Tax Act be amended to clarify that, in determining whether factual control of a corporation exists, factors may be considered that are not limited to legally enforceable rights.

A common example of the potential impact of this change, would be a dentist whose spouse owns a separate hygiene company. Under the existing rules, many dentists and their spouses have taken the position that there is no common control, and that each corporation is entitled to a separate small business deduction. The proposed legislation expands the concept of factual control, and may therefore require the dental corporation and hygiene corporation to share a single Small Business Deduction.

Billed Basis Accounting

Certain professionals are able to exclude the amount of their work in progress (WIP) when computing their income; colloquially referred to as the WIP deduction. However, this amount is included in income when billed. Budget 2017 proposes to eliminate the WIP deduction for taxation years that begin on or after Budget Day. This measure may be transitioned by including 50 per cent of the lesser of cost and fair market value of the WIP in income for the first taxation year after March 22, 2017, with the full amount being included in subsequent taxation years.

Although this change will have a significant impact on the businesses of accountants, lawyers, architects and engineers, it could also impact other professionals, depending on how their business operates and how they manage their billings for work in progress. There could potentially be some impact on orthodontists in particular.

Personal Income Tax

In terms of personal tax measures, there were no changes to personal income tax rates, including no change to the capital gains inclusion rate.

Selling a Practice and Consolidation

The 2016 Budget announced changes to the taxation of goodwill in the context of the sale of a practice, effective Jan. 1, 2017 onward. This change has significantly impacted the after-tax funds available upon the sale of a practice. With the 2017 Budget announcing a study of how private corporations are used, there will likely be more changes coming that could impact the economics of selling a practice. This could have implications for the valuations of practices, as well as on the number of practices available for sale, and the terms under which those practices are bought and sold.

The changing economics of buying, selling and operating a practice may lead more dentists to consider exploring alternative work arrangements. For example, rather than practitioners owning and operating a standalone practice, it’s possible these factors may lead to  increasing consolidation of practices, with more dentists working for large corporate practices.

The federal government has made it clear that it’s revisiting many aspects of Canada’s tax system specific to how private corporations and their shareholders are taxed. We are at the early stages of these changes - there is potentially much more change to come.

For more information on how MNP can help you plan your tax strategy, contact Mark Bernard, CPA, CA, Regional Tax Leader, at 780.451.4406 or [email protected]

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