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As a leading national accounting, tax and business consulting firm in Canada, MNP has been helping professional practices recognize the tax advantages available for professional corporations (PC) for more than 50 years. Some of these tax benefits however, may be curtailed significantly under proposed tax legislation currently being reviewed by the federal government.
Although the rules vary by province, practicing members of most professions — such as law, medicine, dentistry or accounting — can choose to incorporate. Under such an arrangement, the professional is an employee of the PC, which carries on the business of the professional practice.
Most provinces restrict the activities that the PC may carry on and limit the business of the corporation to the practice of the profession or "activities ancillary to the practice." With that being said , the provinces generally permit surplus funds earned by the practice to be left in the corporation and be invested therein, providing a potentially significant tax-deferral advantage.
There are various tax reasons why a professional may wish to incorporate, from the potential for significant tax savings or deferral, the various income-splitting opportunities with a spouse or adult children for certain professions or to take advantage of the lifetime capital gains exemption on the first $824,000 of gains on the sale of the shares of the professional corporation, assuming this is permitted and / or feasible in the professional's province.
The use of a corporation has often been cited as a great tax deferral mechanism, provided the incorporated professional does not need all their cash and can afford to leave some money in the corporation for investment purposes. The reason this works is that the corporation, assuming it qualifies for the small business tax rate, pays tax on its first $500,000 of corporate income at a rate that is significantly lower than the top marginal personal tax rate. This results in significant tax deferral advantage by leaving the after-tax corporate income inside the corporation as opposed to paying it out immediately.
In the last federal election, the Liberals' election platform stated that as the small business tax rate is dropped to 9% from 11% (announced in the Conservatives' 2015 federal budget and passed into law in June 2015), a Liberal government "will ensure that Canadian Controlled Private Corporation (CCPC) status is not used to reduce personal income tax obligations for high-income earners rather than supporting small businesses."
The platform quotes Michael Wolfson from the University of Ottawa, who estimates that "approximately $500 million per year is lost, particularly as high-income individuals use CCPC status as an income-splitting tool.”
So, what could this mean for clients with a PC paying tax at the small business rate — and when? The new Liberal government could take a page out of the 2015 Quebec budget and refocus access to the small business tax rate to private corporations that employ a minimum number of employees. In Quebec, businesses in the service and construction sectors with no more than three employees will no longer be eligible for the Quebec small business tax deduction as of Jan. 1, 2017. This would not eliminate the tax-deferral advantage of incorporation, but would reduce it.
Another possibility for the new Liberal government is to restrict the ability for professionals to split their incomes with a spouse / partner or adult children by imposing a version of the "kiddie tax" that currently applies to private company dividends payable to minor children by taxing them at the highest marginal rate and thus removing the ability to split income. It’s also worth noting, this “kiddie tax” solution for CCPC’s could be far reaching beyond incorporated professionals – affecting CCPC’s across the board. Paying dividends to family members in the low tax bracket allows professionals to save up to $20,000 annually for each dependent.
Recently the Ontario Medical Association sent an email blast to Ontario physicians (one of the groups that could be hit the hardest ), informing them that the Canadian Medical Association (CMA) is “advocating on behalf of physicians on this matter.”
Prior to the election, the CMA wrote to senior federal government officials outlining the “unique nature of medical practice as a business” and stating that “physicians are highly skilled professionals who provide an important public service and are significant contributors to the knowledge economy.” The CMA also added that as self-employed small business owners, physicians typically do not have access to pensions or health benefits and must, in many cases, provide for their own benefits.
Our national healthcare system is likely going to experience significant additional stress due to practicing Canadian professionals deciding to move their expertise to other countries if the tax changes are viewed as being a disincentive to practicing in Canada.
The impact of the anticipated measures on your financial health is significant and could result in a tax hike of as much as 30%, or $30,000 on $100,000 of taxable income. Any changes to the small business tax rules would likely come as part of the Liberals’ first budget, expected in the spring of 2016.
So what can you do? Take advantage by updating your immediate tax planning and putting together a new tax plan for 2016 – a plan that can be quickly implemented once the 2016 federal budget is released. Having effective tax strategies in place will minimize the impact of the new budget measures and your tax exposure.
For more information, contact Calvin Carpenter, CPA, CA, Vice President, Professional Services at 780.453.5360 or
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