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.
OK. Buckle up. Things are about to get complicated, but hopefully after you read this and the next 2 blog articles I’m writing, it will make some sense. Trust me, this stuff is hard enough for accountants and lawyers to get a grasp of. Bottom line: if you’re thinking of selling anytime in the next 5 years, contact me NOW or else you’ll end up paying more in capital gains tax when you ARE selling.
As usual: what I’m writing about isn’t intended to be taken as legal advice; if you need to purify your corporation prior to selling it, contact me.
Lifetime Capital Gains Exemption
Yes, you’ve heard me talk / write about this before. In order to qualify for the lifetime capital gains exemption (and hopefully save a whole bunch of capital gains taxes), there are a number of tests that must be met. For more on that, read this article I wrote HERE and these blog posts I wrote HERE, HERE and HERE.
Now, here’s the situation: leading up to the sale, it’s sometimes the case that one or both of the two tests that need to be met (namely, the 24 month leading up to the sale + 50% active business assets test OR the day of sale + 90% active business asset test) for the dentistry professional corporation needs to be purified.
Purification means: removing offending non-active business assets from the corporation in order for the corporation to be considered a “small business corporation” so that you (as a shareholder) can qualify for the lifetime capital gains exemption (see the 2 asset tests I mention above). Those non-active business assets may include excess cash, investments, securities, real estate in some cases (read this blog HERE and HERE to learn more about real estate and the lifetime capital gains exemption).
And these assets need to go somewhere. Sometimes, those assets will be transferred out directly to the dentist shareholder and / or their spouse, children and parents as a DIVIDEND. But taking a dividend will typically trigger taxes (only cash dividends up to a certain amount – like $33k in 2016 – paid to an adult child who has no other source of income will have $0 federal tax). And what if the dentist doesn’t want to take all that cash out and pay taxes? What then?
What a Typical Corporation Could Theoretically Do…
If we were talking about a typical corporation (other than a dentistry professional corporation), the shareholder would do something called a corporate re-organization in order to transfer assets out of their operating corporation and into a holding corporation. This would be done using steps that look like this: (1) shareholder transfers redeemable shares in operating corporation to a holding corporation and receives shares in the holding corporation as a result AND (2) operating corporation redeems its shares held by holding corporation and non-active business assets are used to satisfy the redemption (in other words: offending non-active business assets are moved out or cancelled, etc.).
Now, I know I used a lot of big words there. And I very much simplified what’s going on. But just bear with me. The key thing to realize is that: inter-corporate dividends made from a Canadian corporation from another Canadian Corporation are typically received TAX-FREE. The receiving Canadian corporation must report the dividends in income but may deduct the dividends in computing taxable income.
In theory, this structure would have been great for a seller to qualify for the lifetime capital gains exemption – because there’s no immediate tax implications! It would also help the seller convert what would have otherwise been a taxable capital gain (on the sale of the shares when they eventually go to sell the shares of the dentistry professional corporation) INTO an inter-corporate dividend that is tax-free.
Let me paint a picture for you: if the dentist had excess cash, the seller could choose to leave that cash in the corporation. Then the purchaser pays an amount equal to the agreed upon purchase price PLUS the excess cash. The seller, assuming they’ve used up their lifetime capital gains exemption, will need to record the proceeds of sale of their shares to INCLUDE the amount paid for the excess cash (because they left it in the corporation). And they’d then have to pay more capital gains tax on the sale of their shares.
Bottom line: removing the excess cash (or other non-active business assets) HELPS the selling shareholders qualify for the lifetime capital gains exemption by meeting the assets threshold tests mentioned above AND also helps them save taxes by converting an otherwise TAXABLE CAPITAL GAIN on the sale of the shares INTO a TAX-FREE DIVIDEND to a holding corporation. WOW! Remember: this is the theory…
BUT: 2 Nuances…
OK, now the bad news: with respect to a dentistry professional corporation, there are 2 nuances: (1) a dentistry professional corporation cannot have a holding corporation (i.e. a corporation that owns its shares), otherwise it would be in violation of the legislation that governs dentistry professional corporations (namely, the Certificates of Authorization regulations) AND (2) in the context of a sale, the Income Tax Act makes it harder to move money on a tax-free basis between two Canadian corporations (basically there are limits on the amount you can move now in the context of a sale). Lets discuss both of these things, shall we?
NO HOLDING CORPORATIONS for DPCs!
Section 2.2 of the Certificates of Authorization Regulations says WHO can be a shareholder in a dentistry professional corporation. And guess what? Another corporation isn’t one of them. Granted, the exact language of those Regulations say that a dentist or their spouse, child or parent may INDIRECTLY hold their shares in a professional corporation (which presumably means through another corporation), the RCDSO has taken the view that this doesn’t mean that. So where does that leave us?
Well, despite what the law and the RCDSO say, some dentists will, for a brief moment in time over a weekend or after hours, do a transfer of their shares in the dentistry professional corporation (operating corporation) to another corporation (holding corporation) in order to transfer non-active business assets out (and it happens in a split second with the redemption / retraction described above). They do it on a weekend or in the evening when the corporation isn’t practicing so that it seems like the corporation isn’t practicing. And in the morning the next day, the dentistry professional corporation is back to normal, having only dentists and their spouses, children and parents as shareholder. Keep in mind: as lawyers, we can only advise you of the risks of your actions; you’re the ones who accept the tax and legal risk(s) and instruct us to proceed.
LIMITATIONS: Section 55(2)
So even if a dentist proceeds to set up a holding company and uses the simple example outlined above to transfer assets out, they may NOT be transferred on a TAX-FREE basis.
Why? Because of section 55(2) of the Income Tax Act. That section is an anti-avoidance rule. When section 55(2) applies, it says that a dividend received by the holding corporation in the context of a share redemption (as was the case outlined above) WILL BE CONSIDERED proceeds of disposition of a share and trigger a capital gain for the holding corporation! Section 55(2) basically prevents the dentist from converting a higher sale price for their shares (for which more capital gains tax would have been paid) into a tax-free inter corporate dividend between two corporations they likely control. I hope this makes sense. But if it doesn’t, just read the example above about the dentist who leaves the excess cash in their corporation and would have had to theoretically pay more in capital gains tax.
To repeat: if section 55(2) applies, it would take aim at the cash or property that is being used to satisfy the redemption of the operating corporation’s shares by the holding corporation. More specifically, it would tax the operating corporation as if those assets were proceeds of disposition (capital gains tax would apply) on the redemption / retraction of those shares.
Are we done yet? No. We need to dig deeper into when section 55(2) applies – because (fortunately) there are exceptions which WOULD allow a dentist to transfer (on a tax-free basis) inter-corporate dividends from a dentistry professional corporation to a holding corporation. So in the next 2 blogs, we’ll dig deeper into when section 55(2) applies and what those exceptions are.
The bottom line is this: if you’re thinking about selling in the next 5 years, you need to immediately speak with us about purifying your corporation to hopefully avoid capital gains tax. If you wait until the last minute (when you’re in the process of selling), you’ll likely be unable to avoid paying those capital gains taxes when you transfer assets (e.g. dividends, etc.) out of your professional corporation and into a holding corporation.
Here’s the idea: you have a dental practice that you own PERSONALLY and you now want to transfer it to your new professional corporation. You don’t want to trigger any income or capital gains taxes on the sale of the assets (e.g. furniture, fixtures, goodwill, computer hardware / software, etc.). But you want to take full advantage of all the tax benefits from having a dentistry professional corporation, which I’ve blogged about HERE. So HOW and WHEN should you do the transfer so as not to trigger any capital gains taxes?
By way of background, a rollover occurs when there is a dentist who enters into a purchase and sale agreement with their professional corporation for the purchase of certain assets. In exchange for those assets, the corporation gives the dentist SHARES that are worth whatever the assets are worth. This way, there is no immediate income or capital gains taxes to pay: that’s because the dentist received in value (i.e. the value / cost of the shares at the time of the transfer) what they gave (i.e. the value of the assets at the time of the transfer).
So, in what follows, I’ll take a look at the two main examples of when dentists do rollovers:
First, if you’re just starting out as an associate, making money, and want to defer paying taxes, etc., it might make sense to have a dentistry professional corporation. Do you need a rollover? Perhaps. Some accountants are very cautious and want associates to transfer their “Associate Goodwill” and any hand instruments they own to their corporation pursuant to a rollover. Some accountants question whether there are any assets to “roll in” to the corporation and simply forgo this step entirely. I guess it comes down to this: what’s your specific situation and what’s your risk tolerance? If you are associating at multiple practices, have your own instruments, have your own patient records, etc. then a rollover of those assets to your professional corporation would definitely make sense. If you’re simply using a professional corporation to earn associate income and that’s it (you have no other assets related to the practice of dentistry, etc.), then it might not make all that sense.
Preparing to Sell
If you’re 2-5 years out from selling, you’ll have enough time to transfer the practice that you personally own to your professional corporation (on a tax-deferred basis) and then ultimately SELL the shares of your professional corporation and hopefully qualify for the lifetime capital gains exemption. Keep in mind that there’s a 24 month share ownership rule that a shareholder (e.g.a dentist) must meet in order to generally qualify for the lifetime capital gains exemption. If the dentist wishes / needs to sell their practice sooner than 24 months, then they should incorporate AND only do the rollover immediately before the sale to the new dentist; this is an exception to the general rule and will allow the dentist to still qualify for the lifetime capital gains exemption.
Is there really no tax consequences?
If done properly, there will be no immediate income or capital gains tax consequences to the dentist when he or she transfers their practice assets to their corporation and takes back shares in exchange. A section 85 election is then filed by the parties.
One thing that often comes up is this: what if the value attributed to the assets and shares? Well, sometimes accountants will do this, but they generally prefer to leave that to appraisers (like getting a letter of opinion from Matt Bladowski of Dental Strategy). What if they get the number wrong? What if the Canada Revenue Agency deems that the practice assets are, on a fair market value basis, actually different in value from what they’ve been represented as in the paperwork? That’s what a “price adjustment clause” is for. This is built into the asset purchase agreement and basically says that if the parties (dentist and professional corporation) get the value attributed to the assets WRONG and the CRA says OTHERWISE after the fact, then the amount will be retroactively adjusted (higher or lower) to reflect the CRA’s number.
That said, there may be HST payable on the value of any real estate or leaseholds. That’s because, in an asset sale, the parties can elect not to pay HST on the sale of assets but this doesn’t apply to real estate and leaseholds. Read this blog for more information.
After the Rollover
Once the rollover is completed, the dentistry professional corporation now owns the assets of the practice (not the dentist).
Please keep in mind that the information provided herein is not legal advice and is meant solely for educational purposes. If you require legal advice, please contact myself, David Mayzel or Ljubica Durlovska.
Over the next series of blogs, I’ll be discussing the importance of estate planning for dentists. In the first blog, I talked about wealth planning for the single, young, debt-laden dentist. In the second blog, I talked about wealth and estate planning for a young, engaged dentist. In this blog, I’ll be talking about wealth and estate planning for the married dentist.
So you’re Married…Now What?
Married couples have lots to think about. Particularly if they have children. Let’s start with some financial planning, shall we?
Shared bank and credit card accounts?
Assuming you trust each other, you may have shared accounts. In the event of death or disability, the other person still has access to these funds, which is great. If there’s a lack of trust when it comes to finances, married couples may want to have separate accounts and perhaps even one shared account that they contribute into (e.g. to pay the mortgage, utilities, etc.). Just remember to have at least 4 months’ worth of income saved up in case of an emergency (new car, new roof, etc.). It might even make sense to have a joint tax free savings account (remember: funds are withdrawn tax-free) for an emergency fund.
If the family home is owned by the married couple equally as “Joint Tenants”, then if one of the spouses dies, the other spouse AUTOMATICALLY INHERITS the other spouse’s interest in the property. This is called the law of survivorship. It applies to jointly held property, bank accounts, etc. It also means that these types of properties pass outside of a person’s estate and therefore won’t need to be probated (no estate administration tax will be paid on the value of the home).
Shares in a Professional Corporation
If a spouse is a dentist and has a professional corporation, thought should be given to whether the other spouse should have shares (and if so, what type of shares). If the objective is for both spouses to be able to take advantage of the lifetime capital gains exemption, then both spouses require to hold so-called “common” or “equity” or “growth” shares. If the married couple plans on having multiple practices and hence multiple corporations, then the amount of shares which one spouse owns in one corporation may be nil or up to 25%. This is because it helps prevent two corporations from being “Associated” and therefore having to share the 15.5% small business tax rate given to small business corporations on the first $500k worth of taxable income. If the two corporations (each owning its own practice) are NOT associated, then they both get the small business tax rate on the first $500k of net income and don’t have to share it!
If one spouse is not going to be using their lifetime capital gains exemption and does not end up getting “common” or “equity” or “growth” shares, then they can still receive so-called “dividend sprinkling” or “special” or “preferred” shares. This allows for income splitting during the course of the marriage. Think: you pay less tax when 2 people are each earning $40k versus 1 person earning $80k themselves. And a dentist who is a shareholder can do this with their parents and adult children. Interestingly enough, if a spouse, parent or adult child has no income from any other source, they can receive upwards of $40k and pay $0 federal tax (there’s a little bit of provincial tax)! Not too shabby. You’ll save a lot of tax that way.
And, as always, don’t forget to have each “common” shareholder have a Corporate and a Non-Corporate Will (to save on estate administration taxes, plus to make specific gifts and appointments), plus Powers of Attorney for Property / Finances and one for Personal Care. I can’t stress this enough!
Employment Agreement with $10,000 Death Benefits
If you have a professional corporation, you can have an employment agreement that stipulates that the corporation pays your beneficiary(ies) upwards of $10,000 upon your death. The corporation gets a $10,000 tax-deduction and the recipient receives it tax free!
Splitting Income By Paying Your Spouse a Salary
It has to be reasonable. There. I said it. You heard it. Now do it. If you don’t want to get into trouble with the Canada Revenue Agency, you have to pay your spouse a reasonable salary for administrative tasks. If they’re also a hygienist or office manager, pay them reasonably for that position. Make sure to have an employment agreement. And that agreement can also contain $10,000 tax-free death benefits (see above!). Again, the idea is that you want to split the income as best as you can to the lower income earner. This reduces the overall tax bill.
Family Tax Cut
The Progressive Conservatives introduced a new measure in 2015 that allows spouses to income split legally (something that can be tricky at times). Here’s how it works: a couple with at least one child who is 17 or younger will be able to split their income NOTIONALLY on their tax return in order to pay less tax as a family unit, up to a maximum savings of $2,000. It was supposed to allow for more tax savings (i.e. you get to offset up to $50k on your spouse who is staying at home and looking after children), but it got watered down at the end so it ended up being only $2,000 worth of savings.
Pension Income Splitting
Did you know that married couples can allocate a portion of certain types of their pension income to their spouse? This would help lower one person’s income tax bill – particularly if one of the spouses is in a higher income tax bracket vis-a-vis the other spouse.
Tax Free Savings Accounts
I’ve written about this here.
Inheritances and Gifts
Did you know that if you are married and receive an inheritance then your inheritance CAN form part of your Net Family Property (and therefore be divided equally with your spouse upon a breakdown of the marriage)? That might not be what you want. Is there anyway to prevent this? Yes. First, if you received the inheritance BEFORE you got married, then it won’t form part of your Net Family Property. Second, if you received the inheritance during the course of your marriage and the LAST WILL AND TESTAMENT of the person (from which you received the inheritance) specified that any inheritance you receive was to remain excluded from Net Family Property, then it won’t be included. Third, if you have a domestic contract (like a marriage contract, prenup or cohabitation agreement that survives marriage), that specifically excludes inheritances of the property or income that forms that inheritance, then it would be excluded from Net Family Property.
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.