Incorporation of Professionals in Ontario
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Donna Ho, CPA, CA, Partner
Depending on your profession, you may be eligible to have a professional incorporation in Ontario. This article details the status of a number of such particular professions, some of the details behind the legislation that allows this (the Ontario Business Corporations Act), the methods and mechanics of incorporation, and the issues to consider when incorporating. Most importantly, throughout the article, we will detail the benefits of professionally incorporating in Ontario, and how it can help you.
Professions Eligible for Incorporation and Their Governing Bodies
The following list represents some of the professions, and their professional bodies, that have been allowed to provide their services through a corporation:
1. Members of Regulated Health Professions:
a. Physicians and Surgeons – The College of Physicians and Surgeons of Ontario
b. Psychologists – The College of Psychologists of Ontario
c. Dentists – The Royal College of Dental Surgeons of Ontario
d. Chiropractors – The College of Chiropractors of Ontario
e. Chiropodists—The College of Chiropodists of Ontario
2. Chartered Professional Accountants – Chartered Professional Accountants Canada
3. Lawyers – The Law Society of Upper Canada
4. Social Workers and Social Service Workers – The Ontario College of Social Workers and Social Service Workers
5. Veterinarians – The College of Veterinarians of Ontario
The governing bodies for these particular professions have the effect of furthering their respective professions by maintaining a standard of quality amongst professional corporations. This is usually enforced through certification or licensing of professional corporations that fall within their jurisdiction. These governing bodies can also keep professional corporations in line by holding the professional shareholders accountable for their actions.
For professionals who are looking to incorporate their practice, their applicable governing body is a good place to start and find out what conditions need to be met to incorporate their specific profession.
Details of the Legislation (Ontario Business Corporations Act)
Along with the descriptions of what professions are eligible for incorporation, there are a number of rules and regulations discussed within the Ontario Business Corporations Act as well. Issues including the corporation’s liability, shareholder and director restrictions, permitted operations, corporate name, and authorization are covered, and we discuss a little about each in the sections below.
The Corporation’s Liability
Professional liability will not be limited in any way by practicing within a professional corporation. A corporation, however, may limit liability with respect to ordinary creditors.
The Corporation’s Shareholder and Director Restrictions
Except for physicians, surgeons, and dentists, only one or more members of the same profession may own any and all of the issued and outstanding shares of the corporation (directly or indirectly). All officers and directors of the corporation must be members of the profession. This ensures that only practicing professionals will make decisions on behalf of the professional corporation.
However, family members of physicians, surgeons, and dentists can become shareholders of their professional corporations, and this includes the professional’s spouse, children, and parents.
For professionals in Ontario, holding companies, family trusts, etc. cannot be used in the corporate structure, which will limit the opportunities for income splitting and asset protection. This same rule does not apply to all provinces within Canada.
The Corporation’s Permitted Operations
The corporation may not carry on a business other than the practice of the profession; however, they may carry on activities related to or ancillary to the practice of the profession, including the investment of surplus funds earned by the corporation. Other than for business purposes, the corporations should not borrow funds to purchase investments.
The Corporation’s Corporate Name
The name of the corporation must include the words “Professional Corporation” or “Sociéte professionelle.” The corporation may not be a numbered corporation. As well, the name must comply with the rules respecting names as set out in the regulations, rules or by-laws governing the profession.
Getting Authorization for the Corporation
In order to legally practice, the professional corporation must have authorization to do so from their profession’s governing body. This authorization will take the form of a certificate of authorization (or similarly named document) and will be issued by the regulatory body to the approved professional corporation.
The Methods and Mechanics of Incorporation
Depending on the current status and stage of your business, there are a number of paths available to take your company to incorporation. Some of these paths and the issues associated with them are highlighted below, including incorporation from a sole proprietorship, from a partnership, or as an employee.
From a Sole Proprietorship
Sole proprietors should be able to transfer all of the assets of their proprietorship to the corporation on a tax-deferred basis. The corporation will receive the assets at their tax basis to the proprietor. In return, the proprietor may receive a promissory note, or have the corporation assume the sole proprietor-ship’s liabilities, equal to the tax basis of the assets transferred. Any liabilities in excess of this amount should either remain with the professional personally or be exchanged for a promissory note payable to the corporation by the professional. If the corporation assumes additional debt, the asset transfer will not take place on a tax-deferred basis. Another asset to be considered in the transfer is goodwill. Goodwill usually has a $nil tax basis but, if the professional paid for the goodwill, it may have a higher transfer price which can be withdrawn tax-free from the corporation. A legal agreement for the purchase and sale between the professional and the corporation will be required for the transfers. This agreement will detail the property to be sold and the combination of shares, assumed liabilities and debt taken back as consideration. In order to determine the fair market value of the practice, it may be necessary to have a valuation of the practice.
From a Partnership
A tax deferred transfer of assets from a partnership to a corporation is also possible, although more complicated both from a tax and legal perspective. The method of the transfer will depend on the desired ending business structure. The partnership may transfer to one corporation owned by all of the former partners or each partner may form their own corporation, which could then form a partnership. The rollover of partnership interests into individual professional corporations allows each partner to have more flexibility; including the flexibility to not incorporate in such a scenario. The above comments regarding debt assumption and goodwill in the context of a sole proprietor also apply in the partnership situation. In the partnership scenario, there is also the potential for a negative partnership equity position. Generally, negative partnership positions should be eliminated prior to the transfers as, if they are not, the partner will realize a capital gain in the year of the transfer. Depending on the particular tax circumstances of the individual, however, this capital gain result may be desirable either because of the current lower capital gains tax rates, or because the partner has unused capital losses.
Professionals who are employees should not incorporate their employment income. The resulting corporation would likely be considered a “personal services business” and, as such, would be taxed at the highest tax bracket. The potential tax advantages of incorporation will only apply to those professionals who are currently considered self-employed.
Issues to Consider When Deciding If and When to Incorporate
Although there are numerous benefits to incorporation, the decision to incorporate your business also has a number of factors to consider. Some of the things to think about before incorporating include the small business deduction, the timing of incorporation, harmonized services tax, your choice of year end, how you will extract funds from the corporation, the small business capital gains deduction, potential opportunities for tax deferral, the relationship between the professional and the corporation, income tax installments, the costs of incorporation and reporting requirements, and agency issues.
The Small Business Deduction (SBD)
The Small Business Deduction is available to Canadian Controlled Private Corporations (CCPC) on the first $500,000 of “active business income“. Income earned by a corporation from a professional practice should qualify as active business income. This means that as long as the professional corporation is a Canadian Controlled Private Corporation, its first $500,000 of active business income in Ontario, may be taxed at a lower tax rate of 15%. There have been several Canada Revenue Agency tax rulings, which if properly structured, allow each member of a professional partnership to incorporate, become an employee of the professional corporation, and charge the professional partnership for his or her services. However, the 2016 Federal Budget now prevents business owners from multiplying access to the $500,000 small business deduction limit. Currently, certain partnership and corporate ownership structures allow each individual owner to access the limit; however, the new measures will enforce all owners to share in the single $500,000 limit.
It is important to speak to both your accountant and lawyer before you proceed to rearrange your partnership.
The professional corporation will also have to share the small business deduction with other corporations that it is associated with. Corporations can be associated if they have common ownership and control. There are a number of complicated rules in the Income Tax Act that determine whether or not corporations are considered to be associated. For example: A management corporation owned by a family trust may be associated with the professional corporation due to a rule that deems shares beneficially owned for children to be owned by the parents.
Each professional will need to review what other corporate shareholdings they and their family members own prior to any tax planning.
The main benefit of incorporation for professionals is the deferral of tax arising from the tax rate differential (the corporate tax rate for a CCPC is 15% on income up to the corporation’s small business limit vs. the personal tax rate – 47.97% from $150,001-$200,000, 51.97% from $200,001-$220,000, then 53.53%% over $220,000). If the professional does not require all of the income produced by their practice to support their personal lifestyle, some of the income could be held by the corporation, invested and the second level of tax (personal) deferred until ultimate distribution. To the extent that no equity will accumulate in the business, the tax deferral benefits of incorporation are greatly reduced.
The physicians, surgeons and dentists have the added benefit of income splitting, since their family members can be shareholders. Depending on their family members’ other income, it could result in significant annual tax savings multiplied for each family member shareholder, even if all the funds are taken from the professional corporation for personal family needs. Of course, proper planning must be done to maximize the benefits.
Timing of Incorporation
A sole proprietor who transfers their practice to a corporation in mid-year will have a deemed year end upon the cessation of the business (at the transfer date) and will not be able to claim capital cost allowance in that year, as they will no longer own any assets. If the capital cost allowance claim is significant, consideration should be given to incorporating immediately after the end of the proprietor’s normal fiscal period. For professionals in partnerships who are transferring their practice to a corporation, care must be taken to time the transfer so that no adverse consequences arise from a negative equity position at the transfer date.
Harmonized Services Tax (HST)
Depending on whether or not the entire practice is being transferred to the corporation, what type of assets are being transferred and whether or not the professional (or partnership) and the corporation are registered for HST purposes, HST may be payable on the transfer of assets to the corporation. In most instances, a joint election may be filed by the vendor and the purchaser so that no HST will be payable on the supply of the business assets.
The Choice of Year End
A new corporation must pick a year-end within 53 weeks from the date of incorporation. There are many factors to consider when selecting a year-end date, including the ability to defer income (bonuses) to shareholders/employees, the business cycle of the corporation and minimizing administration costs.
Extracting Funds from the Professional Corporation
There are a number of possible ways to extract funds from the corporation:
- The promissory notes given to the professional, in exchange for the tax basis of the assets transferred in, may be withdrawn from the corporation as a tax-free reduction of the note.
- The professional may be paid a salary from the corporation. In determining the salary to be paid consideration should be given to utilizing low personal tax brackets, creating RRSP contribution room, CPP contributions, Ontario Employer Health Tax, the timing of payroll remittances vs. personal quarterly instalments and the small business deduction available to the corporation.
- Reasonable salaries may be paid to family members for work performed in business (no different than when unincorporated).
- Income may be left and taxed in the corporation. Later, when the funds are required they may be withdrawn from the corporation as a taxable dividend to the shareholder. The combined corporate and personal tax will approximately equal the tax that would have been paid by the professional if the income had been earned directly. There is an exception to this when the shareholder has no other source of income. There is a benefit from the deferral of the second level of tax until the dividend is paid.
- If you already have a large RRSP or pension, you can consider reducing your salary and take a larger dividend. Due to the tax rates, you would require less cash from the corporation as dividend vs. salary. Then you would invest the remaining corporate cash to replace your RRSP investments. Generally, if the income of the corporation is below the small business limit, the professional will only extract enough salary to utilize his or her low personal tax bracket. If the income of the corporation is above the small business limit, salary dividend planning should be discussed with your accountant given the new personal tax rate increases effective for 2014 and subsequent years. Please note that management fees should generally not be used to extract funds from the corporation, as they will be subject to HST, which will not qualify as an input tax credit to the corporation in the case of the regulated health professions.
Small Business Capital Gains Deduction
When shares of a “qualified small business corporation” are sold, it is possible to use the enhanced capital gains exemption so that up to $835,716 of the sale proceeds are not taxed. In general the shares of a professional corporation will qualify as long as the corporation has not accumulated substantial non-active business assets (each corporation must be reviewed in detail to determine this). However, it is uncommon for medical practices to have any goodwill, unlike dental practices. So for medical doctors, the capital gains exemption is not very relevant. In many cases, the goal is to use the tax deferral and related income for long-term investments within the corporation. In this case, the corporation most likely will not qualify for the $824,176 capital gains exemption. Until the legislation in all professions is changed to allow a corporate shareholder, the only way to make the company qualify for the capital gains exemption is to pay taxable dividends to the shareholder to meet the required asset holding test.
You should discuss the $835,716 capital gain exemption provision with your accountant prior to proceeding.
Potential Opportunities for Tax Deferral
In the corporation, it may be possible for either statutory or non-statutory pension plans to be set up for the corporate employees (including the professional). This is not an option that is available to an unincorporated professional practice.
The estate of a deceased employee (for example, the professional) can receive a “death benefit” of up to $10,000 from a corporation, free of tax.
The Relationship between the Professional and the Corporation
Once a professional practice has been incorporated, the role of the professional changes. Instead of being self-employed, the professional is now an employee, a shareholder and a director of the corporation. As an employee, the professional will receive a salary that is subject to withholdings for income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) contributions.
Payroll remittances will need to be made by the corporation at least monthly (the exact timing depends on the size and frequency of the payroll) and include the income taxes withheld on salaries paid and both the employer and employee portions of any CPP and EI amounts. Please note that there is no EI payable on salaries paid to shareholders owning more than 40% of the shares of a corporation (there could also be no EI on salaries paid to the spouse of the shareholder if their work relation is significantly different from other employees).
While Ontario Employer Health Tax is no longer payable by self-employed individuals, it is still payable by corporations if the total salaries paid in a year exceed $450,000.
If the professional is required to use an automobile in carrying out their duties as an employee of the corporation, the corporation should not purchase the automobile. In most circumstances, it will be more beneficial for the employee to own their own car and receive an allowance from the corporation. A “reasonable” allowance (based solely on business kilometres driven and reimbursement of expenses such as parking) received by the employee, is not included in income.
If the professional is considering leasing an automobile, a cash flow calculation should be done to see if it is beneficial for the company to lease the car.
To the extent that the employee’s/shareholder’s home is used either as the corporation’s principal place of business or on a regular and continuous basis for meeting clients, the corporation may reimburse the employee/shareholder for a portion of their home expenses.
Amounts paid by the corporation for a medical benefits plan for employees are not considered to be a taxable benefit to the employees. Premiums for the employees’ short-term disability plan, if paid by the corporation, are also not considered a taxable benefit. Long-term disability premiums should be included in the employees’ taxable income so that any payments received under the plan are not taxable to them.
Income Tax Installments
Corporate income tax installments are payable monthly; however, installments are not payable during the corporation’s first fiscal year.
Costs of Incorporation and Reporting Requirements
There are legal and regulatory costs to incorporate the company. There are also annual costs associated with maintaining the corporate minute books, preparing the company’s annual financial statements and preparing the corporate tax returns.
Once a professional practice is incorporated, it is critical to ensure that all aspects of the practice are conducted through, and in the name of, the professional corporation and not the individual. This is important to establish the separate existence of the corporation in addition to achieving the income tax benefits of incorporation. A failure to adhere to the legal form and substance of the arrangement may lead to a finding that the professional corporation is carrying on the practice as an agent for the professional. This may result in the business income earned by the corporation being taxed in the individual’s hands. The clients of the professional, and the general public, must be aware that the professional corporation, not the individual, is conducting the practice.