For many practice owners, the decision to sell your practice is a long process which requires you to consider many different factors.The Liberal government has compounded this issue by introducing a new tax change which could result in a larger than expected tax bill for some dentists who sell their practice after December 31, 2016.
Who is affected?
The new tax change affects dentists with Professional Corporation and/or Hygiene/ Technical Service Corporations (PCs/H/TSC) who are considering selling their dental practice assets. The tax change does not affect dentists selling shares of the PC/H/TSC.
While many dentists prefer to sell shares in order to utilize the lifetime capital gains exemption (LCGE), there are instances where selling assets may make sense, including:
1. Dentists who have two or more practices in their PCs but only want to sell one
2. Dentists who have assets (i.e., dental building, investments etc.) they wish to keep inside their PC/T/HSC
3. Dentists who have used up their LCGE and/or do not qualify for the LCGE
If you fall into one of the above and are considering selling your practice in the next year or two, the new tax change could have a large impact on when you sell your practice.
What is the tax change?
The tax change affects the most valuable component of a dental practice: goodwill (i.e. patient charts). Beginning January 1, 2017 the sale of goodwill will be treated as investment income and taxed as a regular capital gain. Investment income inside a corporation is taxed at a high corporate tax rate of 50.20 per cent. In the case of goodwill which is treated as a capital gain, the income from the sale is only 50 per cent taxable. This results in a tax rate of 25.10 per cent (50 per cent X 50.20 per cent). Previously, the sale of goodwill was taxed as active business income with only 50 per cent being taxable. In other words, it received preferential tax treatment compared to other assets like equipment, building
and computers. Under the old tax rules, 50 per cent of the income from the sale of goodwill would be subject to a tax rate of 15 per cent (for income under $500,000) and 26.5 per cent (for income over $500,000). This meant an effective tax rate between 7.5 per cent (50 per cent X 15 per cent) and 13.25 per cent (50 per cent X 26.5 per cent) depending on how much income was reported in the year.
How does it affect me?
One of the benefits of selling assets is that the vendor keeps their PC/H/TSC and the money received after paying corporate taxes from the sale is held inside the corporation until the dentist decides to pay it out as dividends. This could take place over several years and/or be paid to several shareholders reducing personal taxes for the family. For example, a million dollars could be paid out over a decade at $50,000 per year to the dentist and their spouse which would be a lot less tax than paying out $1 million to the dentist all at once. The new tax change reduces this benefit severely as the upfront corporate taxes have been increased from between 7.5 per cent and 13.25 per cent to 25.10 per cent.
How much more will I pay upfront?
On a sale of patient charts for $1 million, expect the following corporate tax bill:
|Sale date||December 31, 2016||After Jan 1, 2017|
|Sale Price for Goodwill||$ 1,000,000||$1,000,000|
|Corporate taxes||$ 75,000 to $132,500||$251,000|
The difference between selling your practice goodwill on December 31, 2016 and January 1, 2017 could be as high as $176,000 in corporate taxes. Some of these corporate taxes are refundable to the corporation, but would require shareholders to receive dividends (i.e. incur personal taxes).
What can I do?
1. Plan well in advance. Speak to your advisors if you are considering selling your practice. The earlier the better.
2. Sell your practice assets before January 1, 2017. Keep in mind that in many cases, from start to finish, transactions can take several months before they close. Hence, planning for a December 31st closing date could be risky especially given the holiday season. To be on the safe side, you may want to set a closing date well in advance of December 31, 2016.
3. Sell shares. Speak to your advisors to weigh the pros and cons of a share sale versus an asset sale. With the new tax change, it could make sense to sell shares even where no LCGE is available.
4. Plan your dividends. Timing the dividend payout from the sale of your practice and paying dividends to low income shareholders will help you reduce your overall tax bill if you sell after January 1, 2017.
We have emphasized in the past the importance of planning at least three years in advance for the sale of your practice. Tax changes have the ability to shorten the amount of time you have to make a decision to a matter of weeks and possibly even days. Between securing employment contracts for your employees, securing a premise lease which will be desirable to the banker/buyer, preparing an appraisal, finding a buyer, negotiating terms and completing the deal, December 31, 2016 is not that far away. The last thing you want is to be sitting on the fence on December 31, 2016 staring down a $176,000 tax bill as the clock strikes midnight and everyone else is ringing in the New Year.
This article was prepared by David Chong Yen, CPA, CA, CFP and Louise Wong, CPA, CA, TEP of DCY Professional Corporation Chartered Accountants who are tax specialists and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org / email@example.com. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.