I have blogged extensively about how dentists can qualify for the lifetime capital gains exemption in this blog. I’ve blogged about certain nuances here (dealing with real estate) and here (dealing with issuing shares).
In the next series of blogs, I’m going to tackle some of the nuances surrounding the lifetime capital gains exemption (LCGE) to help educate dentists on how they can qualify to take advantage of potentially huge tax savings. in this blog, I’m going to tackle that 50% asset test. And in the next blog, I’m going to talk about the 90% asset test.
I’ve blogged about this previously, but let’s discuss in further detail, shall we?
Recall that the Income Tax Act says that shares of a qualifying small business corporation (typically, your dentistry professional corporation) will only qualify for the LCGE if, for the 24 months leading up to the sale, more than 50% of the fair market value of the assets of your dentistry professional corporation was used principally in an active business carried on primarily in Canada.
OK, so there are a lot of things going on with this test. Let’s dive in deeper, shall we?
Relationship with 24 Month Share Ownership Rule:
Does this test require a dentistry professional corporation to exist and have assets for at least 24 months prior to the sale? No. The section of the Income Tax Act says that this asset test must be met throughout the period while the shares of the dentistry professional corporation were owned by the shareholder (i.e. the dentist). Now, yes, there is a general 24 month share holding rule (which I discussed in a previous blog here) in order for a dentist shareholder to qualify for the lifetime capital gains exemption. But I also talked about an exception to the rule: a dentist sole proprietor who owns their practice personally can incorporate their business shortly before a sale (i.e. transfer their practice to their corporation on a tax-deferred or rollover basis), sell shares of the dentistry professional corporation and claim the LCGE. And in this situation, the 50% asset test can be met – even if the dentist shareholder held their shares for less than 24 months! Nice…
If at any time the fair market value of the corporation’s non-active business assets comprise more than 50% of the overall value of its assets, then the corporation will be offside and the shares won’t qualify for the LCGE. This could happen because of a mistake – for example, failing to transfer excess reserve cash out of the corporation. If this happens, then the 24 month clock STARTS ALL OVER AGAIN! Ouch!
I’ve blogged about this previously. An active business is defined in section 248(1) of the Income Tax Act as any business carried on by the dentistry professional corporation OTHER THAN: (1) a specified investment business or (2) a personal services business. For a specified investment business, think: a business that primarily generates income from passive income from property (e.g. rent, royalties, etc.). So a corporation that owns and rents out real estate, or is an investment holding corporation, and which has only three or four employees will NOT qualify as an active business. A personal services business is essentially an incorporated employee in disguise. Think: an associate who is essentially an employee of a practice but who incorporates to take advantage of all the tax benefits of having a corporation (but in reality, they’re still an employee) and their corporation has only a few employees involved.
Fair Market Value
Now, when we’re looking at “fair market value”, we’re actually looking at the GROSS FAIR MARKET VALUE of the assets (not net of liabilities!). So if a dentist shareholder advances funds to a dentistry professional corporation to allow it to pay off its liabilities leading up to a sale, the amount advanced will be viewed as an asset and the corresponding liability to the shareholder (which is normally the case) will be ignored for the purposes of determining whether 50% of the fair market value of the assets of the dentistry professional corporation are active business assets. This was stated to be the case in CRA technical interpretation 2003-0030045 dated October 10, 2003.
The term “Used”:
At least 50% of the dentistry professional corporation’s assets have to be “used principally” in an active business. The CRA has stated the following in CRA technical interpretation 9606355 dated March 16, 1998 concerning its interpretation of the term “used” in an active business:
The term “Principally”:
The word “principally” in the term “used principally” has been interpreted by the CRA to mean at least 50%. The CRA will look at each asset of the corporation and determine, in light of various factors, whether it is “used principally” in an active business carried on by that corporation. Some assets have more than one use – like real estate. So what about a building that is owned by a dentistry professional corporation and which houses the dental practice? Well, if that building leases more than 50% of its space to tenants other than the dentist and their dental practice, then the entire real estate assets may NOT be used principally by the dentistry professional corporation. I’ve blogged extensively about real estate and whether it will qualify for the lifetime capital gains exemption here. But if the dentistry professional corporation uses most of the building to house the dental practice and less than 50% for other tenants, then the entire asset may qualify as an asset “used principally” in an active business.
The Term “Carried On”:
For an asset to be “carried on” in an active business, this is a pretty simple test to meet: the asset must assist the corporation in carrying on an active business. So if the asset is simply sitting there and not being used to carry on an active business, it won’t qualify (think: vacant land held by the dentistry professional corporation for re-sale) and could put the dentistry professional corporation offside.
The Term “Primarily in Canada”:
Recall that the asset must be used principally in an active business carried on “primarily in Canada”. This would be an easy enough rule for an Ontario dentistry professional corporation with operations (a dental practice) located in Ontario, Canada.
In the next blog, I’m going to talk about the 90% Asset Test
Please note the this blog is provided for educational purposes only and does not constitute legal advice. You should seek professional help by contacting a dental lawyer (such as myself) or a dental accountant (who I can refer you to) if you are looking to qualify for the lifetime capital gains exemption.
Please note that the information provided herein is not legal advice and is provided for informational and educational purposes only. If you need legal advice, contact me (Michael Carabash) or David Mayzel.
A “Prenuptial Agreement” is a written contract between two people who intend to be married. A Prenuptial Agreement refers to the fact that it is entered into BEFORE marriage. During the course of the marriage, however, the couples may enter into a similar contract which is called a “Marriage Contract”. The name doesn’t really matter: it’s just important to realize that they can be entered into prior to or during the marriage. These Agreements deal with the parties’ respective rights and obligations during and after their marriage (or on death) and can deal with things like: ownership or division of property, support obligations, the right to direct the education and moral training of children, and any other matter in the settlement of their affairs (s. 53 of the Ontario Family Law Act). Importantly, a Domestic Contract CANNOT say who will have custody of, or access to, children if the relationship ends. Furthermore, a Domestic Contract cannot prevent a spouse from being in possession of the matrimonial home – irrespective of who owns it! This is discussed in greater detail below. Finally worth mentioning is that a Domestic Contract does not need to deal with all rights and obligations concerning the relationship: it can only be concerned with one asset (e.g. a house, the shares of a dentistry professional corporation, etc.) or one obligation (e.g. support to one party upon termination).
When are they used?
Domestic Contracts are used by couples who are not necessarily living together but who plan on getting married. They are used by parties who want certainty, predictability and control over their financial affairs in case the relationship breaks down. There are a number of reasons why couples or particular spouses may insist in having a Domestic Contract. First, a spouse who is wealthier than the other spouse may want to avoid having to share their increased wealth if and when the marriage breaks down. With a Domestic Contract, certain assets – such as pensions, real estate, the shares of a dentistry professional corporation etc. – can be kept away from the other spouse if this happens. Second, a Domestic Contract can be used to make special arrangements for particular property in which one or both spouses have an interest. Such property may include business interests (e.g. dentistry professional corporations). A Domestic Contract may allow the parties to determine who owns what upon a breakdown of the marriage, instead of just having legislation and courts make that determination. Finally, a Domestic Contract can be used to establish specific spousal obligations in advance of the marriage breaking down.
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.