Bottom Line: Use Em If You Got Em!
In the recent tax court case of Zhang v. Her Majesty The Queen, 2017 CarswellNat 7397, the Tax Court of Canada had to interpret the law when it came to a dentist using OR deferring the use of their education and tuition tax credits. So Dr. Hui Zhang had accumulated $52,040 in tuition and education tax credits. Dr. Zhang COULD use them for her 2014 tax year; in that year, she earned dividend income from her professional corporation. She decided NOT to use any tuition and education tax credits that year. So she figured she could use them (carry forward) in 2015. And that’s what she did: when she filed her 2015 tax return, she claimed $52,040 in tuition and education tax credits. But the CRA (Minister of National Revenue) DENIED HER CLAIM!!! According to them, she didn’t have any credits because they had been applied in her 2014 tax year. Dr. Zhang took the CRA to court.
The Tax Court of Canada looked at section 118.61(1) of the Income Tax Act, which contained a formula for determining the amount by which an individual’s unused tuition, textbook and education tax credits are to be determined. In 2013, that section said you need to use this formula:
A + (B – C) – (D + E)
The U.S. just passed a major tax overhaul (the first since 1986) that will decrease corporate tax rates from 35 to 21 percent. The idea here is that the tax savings will be used to create jobs and reinvest in R&D, infrastructure, etc. Some are saying, based on what’s been done in the past with big corporate tax breaks, that the money saved will be used to reward shareholders by paying out dividends or buying back shares. Some companies are already talking about paying bonuses to their employees and going on a hiring spree. Time will tell if cutting taxes results in more and better jobs.
So what’s going on in Canada? It’s been confusing to say the least. First, there was an all-out assault on those greedy dentists, doctors, lawyers, accountants – pretty much anyone who was a professional – because of perceptions that they earned a lot of money. Income splitting? How dare they! Earning passive income in their corporations? Shame on them! Multiplying the lifetime capital gains exemption? How Rude!
But the problem, whether the Liberals could foretell it or not, was that by attacking these professionals, they were attacking EVERY small business owner – including farmers and fishers.
OK, said the Liberals. So we’ll make things better by not going after capital gains and watering down the whole taxation of passive income thing we originally proposed. But we’re keeping our wonky and unclear proposal on income splitting with family members because at least we can do something there…
But then the Liberals started to take a lot of heat – Finance Minister Morneau personally – for what he knew and did with his shares of his family’s pension company and whether it constituted a conflict of interest. So things died down a little bit with the whole ‘let’s go after doctors, dentists, etc.’. And then things got even worse for the Liberals with the Paradise Papers, because it was discovered that BILLIONS of dollars from Liberal campaign financiers were being diverted OFFSHORE. BINGO!!!!
If Trudeau and Morneau want to go after anyone to help raise taxes for their endless spending on infrastructure (with no apparent plan on how much it will cost), they should be going after the offshore entities. They should tell them – like the Americans are now doing – that if you bring in your money back to Canada to invest HERE – that you’ll be taxed at the low corporate tax rate (say 15%) and that’s it. No penalties or interest or anything else. Now you can bring your money back here in 2018 and not worry. And the government now has their tax dollars to use on infrastructure.
But no… that would be a smart move. So the Liberals won’t do that. Instead, they’ll slightly lower the corporate tax rate (from 11% now to 10% in 2018 to 9% in 2019) as a way to give a crumb while stealing the cookie. So they’d rather not go after their friends parking money offshore; but it’s OK to go after the little guy? WTF…
So where are we at now? Well, as of a few weeks ago, the Liberals once again tweaked their proposals to try to persuade people that it (1) won’t affect that many (only 45,000 family businesses) and (2) will help the government raise the taxes it needs for infrastructure and (3) it’s easy and simple to follow. And with respect to the latter 2, I’m highly skeptical…
OK, so what does this mean for dentists?
New tax rules may be coming. They’re called a “Tax on Split Income” and they’re at the highest tax rate! The only way for them not to apply is to fit within an “exclusion” – of which there are “excluded business”, “excluded shares” and earning a “reasonable return”. Let’s talk about each in turn with respect to dentists and their dentistry professional corporations and SIDE corporation (hygiene corps, technical services corps, management corps, etc.).
Well, let’s take a look at the typical professional corporation.
Bottom line: if dividends are paid from a Dentistry Professional Corporation to an adult spouse who owns 50% of the common equity shares (though they are NOT a dentist) AND THEY ARE NOT AND HAS NOT BEEN EVER actively involved in the business, TOSI applies under the proposed rules. Why? Because the Dentistry Professional Corporation is NOT an “Excluded Business” and the Shares upon which dividends are paid to the spouse are NOT “Excluded Shares”.
Here’s the rationale…
FIRST, TOSI doesn’t apply to so-called “Excluded Businesses”. An “Excluded Business” is a business in which the individual receiving the dividends would have been actively engaged on a REGULAR, CONTINUOUS, and SUBSTANTIAL BASIS in the taxation year in which an amount is received OR in any five (5) previous taxation years. An individual will be deemed to be actively engaged if they work in the business at least 20 hours per week during the portion of the year that the business operates or meets that requirement for any five (5) prior years (need not be consecutive). In our hypothetical example, the spouse wouldn’t meet this test because they have NOT EVER been actively involved in the business.
SECOND, TOSI doesn’t apply to “Excluded Shares”. “Excluded Shares” are shares of a corporation that has the following characteristics: (1) less than 90% of the corporation’s business income came from providing services and the corporation is NOT a professional corporation; (2) the shares represent more than 10% of the value and equity of the corporation and (3) all or substantially all (80-90%) of the income of the corporation is not derived from another Related Business in respect of the individual receiving the dividends. So, in our example, the dividends received by the spouse wouldn’t qualify as “Excluded Shares” because the corporation IS a professional corporation. The government is singling out dentists and doctors with this provision.
THIRD, if the person receiving the dividends is 25 years or older and the dividends they receive represents a “Reasonable Return”, then TOSI won’t apply to that extent (that it was a “reasonable return”). A “reasonable return” is hard to define. The draft legislation says it takes into consideration the following factors relating to the relative contributions of the individual receiving the dividends: the work they performed in support of the related business (the dental practice), the property they contributed in support of the related business, risks assumed, and such other factors as may be relevant. WTF??? Likely a dentist’s family member won’t be able to meet this “reasonable return” test because they don’t co-guarantee the loan used to buy the equipment and leaseholds, don’t work in the office with the dentist, and don’t assume much risk (because they’re not the dentist).
What about hygiene, technical services, and management corporations?
Many dentists have used another corporation to provide services to the dentistry professional corporation for years, as a way of income splitting with spouses and family members (parents, children, etc.). Well dividends paid from that “SIDE corporation” to a dentist’s spouse who IS NOT AND HAS NOT BEEN involved in will LIKELY be subject to TOSI. Here’s why:
FIRST, TOSI doesn’t apply to an “Excluded Business”. In our example, unless the family member of the dentist who received dividends from this SIDE corporation are actively involved in the business (e.g. providing administrative functions like bookkeeping / payroll / reception services, perhaps is a hygienist or an assistant, etc.), they will NOT meet the 20 hour threshold rule. The CRA is of the view that the individuals receiving the dividends should keep timesheets, schedules or logbooks to prove that they’ve been meeting this 20 hour threshold rule. An excluded business is one that the individual receiving the payment is engaged on a regular, continuous and substantial basis in the activities of the business in that current tax year or any five (5) prior tax years. The last part is a somewhat saving grace. That suggests that, if the taxpayer receiving the dividends TODAY was at some point in the past 5 years, contributing at least an average of 20 hours per week during the portion when business operated, then they could receive dividends and those dividends wouldn’t fall under TOSI. So hypothetically, if an adult family member of the dentist DID work an average of 20 hours per week THIS year in the SIDE Corporation, they could stop working and still receive dividends for the next 4 years without working at all in that SIDE Corporation? Could this be a regular habit of having a family member work once every 5 years just to avoid TOSI? Just keep in mind that the proposed definition of an excluded business means a business where the individual receiving the dividends is engaged on a regular, continuous and substantial basis in ANY five (5) prior taxation years.
Second, what about “Excluded Shares”? Well, the individual receiving the dividends can clearly own more than 10% of the votes and value of shares of the SIDE Corporation; and this SIDE corporation likely isn’t a professional corporation. So we’re good there to avoiding TOSI according to the definition of “Excluded Shares”. But what about the other 2 tests? That’s where we run into trouble. First, it’s more than likely that 90%+ of the business of this SIDE corporation is to provide services. And second, all or substantially all of the income of the corporation is income that IS NOT derived from a related business. What’s a “related business“? Well, that’s a business carried on by the dentist (an individual who is RELATED to the individual getting dividends in the SIDE Corporation). So if the dentistry professional corporation (carried on by the dentist) is providing all or substantially all of the SIDE Corporation’s income and the shareholder of the side corporation is related to the dentist, then that shareholder wouldn’t be holding “Excluded Shares”.
Third, what about a “Reasonable Return” exclusion? Well, once again, this is going to be difficult to justify given that the dentist’s family member earning those dividends from the SIDE business didn’t (per our example) work or contribute property or assume risks to help support the related business (i.e. the dental practice).
This is just me ranting and raving… I get pissed when good, hardworking folks who try to build that ‘Canadian dream’ of having their own small business get taken to the cleaners by some far-off government people for the purposes of having SOMEONE pay for their ill-founded projects (one of which is an infrastructure plan with apparently no spending limit and another of which was a behind-closed door multi-million dollar settlement to a convicted terrorist).
And so the Trudeau Government is holding a consultation period over the summer to basically find out how to tax small business owners who legally pay family members through the use of a corporation (among other things). In media articles, it looks like they’re going after professionals – like dentists and doctors. And it also looks like they’ll be targeting DIVIDENDS that are paid to family members. The government has said that children in the 18-24 years age bracket appear to be best suited (given that they avoid kiddie tax rules and given that they don’t have high incomes) for income splitting strategies involving their parents.
Here’s the thing about DIVIDENDS: you can ‘sprinkle’ them on other shareholders – presumably in lower income tax brackets – in order to arrive at a lower effective tax rate on the whole (as opposed to one person taking all of the money for themselves). For dentistry and medicine professional corporations, they are VERY restricted in terms of WHO can be a shareholder: a dentist, their spouse, their parents, their children, or the dentist or their spouse in trust for a minor child. And guess who else can’t get dividends from dentistry and medicine professional corporations – that’s right: other corporations (because other corporations can’t hold shares in those corporations). And those dividends could have been transferred essentially on a tax-free basis if they were capable of going to another Canadian corporation. By the way: lawyers and accountants cannot split income using dividends with their family members (or anyone else) through their professional corporations.
So why is the government so unhappy with these dividends that are sprinkled on family members? It’s because they can be earned AFTER TAXES have been paid by the corporation on active business income AND THEN PAID to the shareholder WITHOUT the shareholder having to contribute in any way possible to the corporation. That’s right: a shareholder can simply sit back and collect money. With a professional corporation, family members who are shareholders BUT who aren’t the dentist or the doctor don’t get a right to vote, so they have even less say on what happens with the corporation.
Well, apparently, the Trudeau Government doesn’t want dentists and doctors to continue to be able to sprinkle such dividends on non-professional family members without paying more taxes. But this is so wrong for so many reasons, as follows:
Do we actually need new legislation? I’m not convinced. Why?
First, we already have a ‘reasonableness’ test when it comes to salaries paid to family members and whether the expenses to the corporation (i.e. those salaries and benefits) are considered ‘reasonable’. If they’re not considered ‘reasonable’ in light of the family member’s contributions to the corporation, their skill-set and experience, their time spent on the job, etc., then the CRA can deny / reduce that expense and have the corporation pay more income tax.
Second, we already have rules called the Personal Services Business (discussed HERE and HERE). which basically means that if you’re nothing more than an incorporated employee, you’ll be denied the tax benefits of having a corporation. The IT industry, for example, has been targeted heavily by this provision and the CRA has gone after so called ‘independent contractor’ IT personnel who were nothing more than incorporated employees.
There’s my rant.
Now, let’s take a brief look at what the government is proposing, shall we? You can find their discussion paper and draft legislation, as well as submit comments up to October 2, 2017 here: http://www.fin.gc.ca/activty/consult/tppc-pfsp-eng.asp and here: http://www.fin.gc.ca/n17/17-066-eng.asp
With respect to what they’re proposing, here’s the idea… They want to EXPAND the application of an existing tax. That tax is called a “Tax On Split Income” (“TOSI“). TOSI was introduced in 1999 and it applied to income, such as dividends on unlisted shares from a business activity of a related individual, earned by minor children shareholders (those under 18 years old). In other words: TOSI was kind of a kiddie-tax that applied to minors who received dividends through their parent’s professional corporation. If TOSI applied, that dividend income was subject to a top flat-rate person income tax in the hands of the minor while personal tax credits (except dividend and foreign tax credits) would be denied for those amounts.
Well, the Trudeau government now wants to make TOSI apply to dividend income earned by ADULT children shareholders. And they want to add a “reasonableness test” to determine if the income amount received by the shareholder is commensurate with what would be expected in a similar arm’s length arrangement. Finally, they’re introducing the definition of ‘connected individual’ to determine if an adult’s income from a corporation should be treated as split income. A Canadian resident individual with a certain measure of influence over a corporation would be treated as connected with the corporation.
In the next few blogs, I’ll be digging deeper on what these changes could mean to dentists IF they become law…
Stay tuned and don’t forget, if you’re not happy with these changes, to GIVE ‘EM HELL by sending your comments HERE: http://www.fin.gc.ca/activty/consult/tppc-pfsp-eng.asp.
Since taking office, the Trudeau Government has introduced higher tax rates for those earning the most (i.e. those who’ve worked hard to build their business).
The Trudeau Government has eliminated the previous government’s income splitting among family members tax benefit, which was designed to help one-earner families where the other spouse stays home to take care of children. They’ve now taking aim at the use of professional corporations to split income among family members by paying dividends (details coming in the next few months about this one!).
There’s also been historical talk / rumour about changing the rules for corporations to qualify for the 15% small business tax rate (you would need to have a certain minimum number of employees) AND increasing the inclusion rate for the lifetime capital gains (from 50% to 75%).
The Trudeau Government doesn’t seem to care if you have a pension built up in your professional corporation; they want to force you to spend your hard-earned money hiring people you may / may not need and NOT keeping money in your bank account for rainy days and retirement. They want you to pay more taxes to help pay for their infrastructure plan – which by the way, we have NO IDEA how much it will end up costing!
They are unfairly casting a wide and destructive net across all of Canada’s small business owners – which employ 80% of Canadians! Taking away these tax benefits makes wanting to do business in Canada LESS ATTRACTIVE. They are contributing to another brain drain (like in the past, when smart doctors and professionals threatened to leave unless they had certain tax benefits put into place).
We need dentists, doctors, and other small business owners to WANT to come and stay in Canada, hire employees, and be able to save for their own retirement. They feed entire industries and by unfairly targeting them, we make Canada look way too socialist. Why should the government strip away tax benefits for those who took risks to start their own business; who have to think about their businesses day and night; who need to worry about regulations / insurance / taxes / dealing with professionals. Everyday employees don’t have these burdens. They shut off at 5:00 p.m. and don’t worry on weekends. If they lose their jobs, they can find another. If a small business owner like a dentist goes bankrupt, they lose it all and have a social stigma. There’s more risk to having your own business; so the rewards should be greater. That’s how capitalism works!
The Trudeau government should stop picking on those who risk more and add such great value to our wonderful country. And stop trying to tell us what we should be doing with our money by punishing us if we don’t toe the Liberal Party’s line!
Just some thoughts…
Yes, it’s true. The Ontario Ministry of Finance has started to audit dentists in order to ensure they have paid enough Employer Health Tax (EHT) for all employees. And they’re disputing dentist’s characterization of hygienists and associates as independent contractors (instead of employees)(! If they believe they should have been employees, then the practice would be on the hook for paying EHT, plus interest and penalties!!!
This is VERY BIG NEWS because, industry wide, many associates are considered independent contractors and their contracts are set up in that manner. But just saying in an agreement that a hygienist or an associate is an independent contractor ISN’T ENOUGH to actually make them so.
Canadian courts use the following four-fold criteria to determine whether a person is legally considered to be an independent contractor:
See Montreal v. Montreal Locomotive Works Limited,  1 DLR 161 (PC); Wiebe Door Services Ltd. v Minister of National Revenue,  2 CTC 200; and 671122 Ontario Ltd v Sagaz Industries Canada Inc., 2001 SCC 59.
Individuals who exert control over their own work, own their own tools, have the chance to profit and run the risk of loss will generally be considered independent contractors.
Importantly, the Supreme Court has held that there is no conclusive test to determine whether a person is an independent contractor or an employee The Courts will look at the totality of the relationship to determine if an individual is an employee or an independent contractor. More specifically, all of the facts must be considered in light of the common understanding of the parties’ legal relations. In other words: (1) was the subjective intention of the parties established or reflected in writing and / or by action and (2) does the objective reality, based on the four-fold criteria set out by the courts, sustain or deny the subjective intention of the parties?
See Royal Winnipeg Ballet v. Minister of National Revenue (2006), 2006 CarswellNat 2425 (Federal Court of Canada).
If you’ve been contacted by the Ontario Ministry of Finance about this, contact DMC LLP immediately and we will work with you to help get you the best possible results. If you haven’t been contacted yet, contact DMC LLP right now to help PREVENT this from happening by having your contracts drafted properly and the realities reflect a more truly independent relationship.
David Mayzel is your legal risk manager. He is a trained courtroom lawyer and has spent many years resolving disputes both in and out of court. He knows how to prepare documents and execute transactions in a way that avoids or mitigates legal risks. He can be reached at 416.528.5280. or email@example.com.
Michael Carabash is your business law adviser. He is an entrepreneur at heart who helps you see the big legal picture. He drafts clear and effective agreements that protect your rights while promoting your interests. He can be reached at 647.680.9530. or firstname.lastname@example.org.
Ljubica Durlovska is your transition lawyer. She helps you with staff and associates, maintaining your corporation, and other business matters. She can be reached at 416.443.9280, extension 206 or email@example.com.
Jonathan Borrelli is your employment lawyer. He helps you with staff and associates matters, including hirings, terminations, switching staff to written contracts and resolving disputes. He can be reached at 416.443.9280, extension 204 or firstname.lastname@example.org.
Benjamin Kong is an experienced business law clerk. He assists David and Michael with corporate matters and purchase / sale transactions. He can be reached at 416.443.9280, extension 207 or email@example.com.
Julie Whitehouse is an experienced business law clerk. She assists David and Michael with corporate matters and purchase / sale transactions. She can be reached at 416.443.9280, extension 203 or firstname.lastname@example.org.
David, Michael, Ljubica, Jonathan, Ben and Julie are a truly dynamic team. Their diverse knowledge, skills, and experiences will help you get the best deal possible while promoting your interests and protecting your rights. You can read dentist testimonials here.