On July 18, 2017, the federal government proposed changes to the tax laws aimed at dentists and other professionals who have been using private corporations including professional corporations (PC), hygiene service corporations (HSC), technical service corporations (TSC) and holding corporations (Holdco) as tax-savings vehicles. After the consultation period ended, the government provided some updates during the week of October 16, 2017.

 

  1. Income splitting via salary/dividends

 

What has the government announced?

The government will move forward with measures to limit income sprinkling (i.e. introduce reasonableness tests for dividends paid to adult family members) using private corporations.  However, the government has committed to making some changes to simplify the original proposals. Details are not yet available at this time but the reasonableness tests to determine family members’ contributions will likely still be based on the following basic principles:

  • Labour contributions to the business;
  • Capital or equity contributions to the business;
  • Financial risks assumed, such as co-signing a loan or other debt; and/or
  • Past contributions of labour, capital or risks assumed.

 

What does this mean for you?

Income sprinkling/splitting with family members using private corporations appears to have been limited. Effectively January 1, 2018, dividends paid to family members will be subject to the reasonableness tests, thereby restricting dividend payments and tax savings.

 

What should you do now?

It is critical that large dividend payments be made to shareholders in 2017 before this tax savings window closes.  These dividend payments should be sufficient to take advantage (likely for the last time) of those shareholders with little or no income, who are in lower tax brackets.

 

  1. Multiplying and Claiming the Lifetime Capital Gains Exemption (LCGE)

 

What has the government announced?

The government will NOT be moving forward with measures that limit access to the LCGE.

 

What does this mean for you?

This is great news. Family members who are equity shareholders (i.e. own shares that have or can accumulate value) of your corporation are still entitled to claim their LCGE.

 

What should you do now?

Although the LCGE has been preserved, a common sense and conservative approach, in our opinion is to claim/crystallize the LCGE, as each LCGE of $835,716 is still worth about $220,000 in actual savings. Dentists and each family member who are equity shareholders can still claim their LCGE without selling the practice. Claiming it sooner rather than later means if the government decides to take away this tax savings opportunity in the future, dentists and their family members would have already captured this tax savings. Those who do not crystallize their LCGE are gambling with their tax future/savings. What if the government decides to take away this tax savings opportunity later?

If you have qualifying family members who are not yet equity shareholders of your PC/HSC/TSC, consider making them equity shareholders to multiply the tax savings related to the LCGE. The sooner they are made equity shareholders, the more capital gains could be attributed to them (i.e. the more tax savings which can be generated).

 

Prior to claiming the LCGE, each individual shareholder and each private corporation must pass certain tests. Two of these tests restrict the amount of passive investments, including excess cash, stocks, insurance, bonds etc. “owned” by private corporations. Therefore it is prudent/ideal to claim/crystallize your LCGE before accumulating passive investments within your private corporation. If you already have accumulated passive investments inside your private corporation, then these investments need to be removed from the private corporation before the LCGE can be claimed. Additionally, some time constraints are imposed on when the investments must be removed. Consult your tax advisor.

 

In determining when to claim/crystallize your and your family’s LCGE, you should take into consideration the costs (i.e. professional fees) involved with such a maneuver and the likelihood of LCGE being taken away.  If the full LCGE cannot be claimed at this time and you anticipate the practice value to grow in the next few years that could further increase your LCGE claim, it may make sense to defer claiming/crystallizing your LCGE to reduce additional costs that you may otherwise incur on multiple crystallizations. Again, we suggest consulting your tax advisor.

  1. Deferring taxes on passive investment income held by a corporation

 

What has the government announced?

The government will move forward with measures to limit the tax deferral benefits of passive investments within private corporations. No details are provided at this time as to what the new rules will be or when they will become effective.  However, to provide flexibility for business owners to save for various business and personal circumstances that may arise, the government will ensure the following:

  • The new rules will only apply on a go-forward basis.
  • The new rules will not apply to passive investment income (for future investments) below an annual threshold of $50,000.

 

What does it mean for you?

Your PC/HSC/TSC/Holdco’s existing investments and any future income earned from these investments will be protected and will not be affected by the new rules in any way.

 

You can continue to use your PC/HSC/TSC/Holdco to save for retirement. Assuming an annual return of 5%, you can have up to $1 million of (new) passive investments in your corporation before the new rules would have any tax implications.

 

What should you do now?

Continue to invest the corporate cash based on your own risk tolerance level. Consider the following:

  1. Buying another dental practice, dental equipment, and/or dental building which accommodates your practice. These dental related assets/investments are not considered passive investments. Any income generated from these dental related investments are “active”/good income (from the tax department’s perspective) and are not caught by the passive investment income net;
  2. Use surplus cash/investments to pay down/off any practice loans;
  3. An individual pension plan;
  4. Investing in investment vehicles which attract little or no taxes such as certain types of insurance;
  5. Investments which do not pay dividends or pay little dividends but “grow” in value; and
  6. Pay a tax free capital dividend.

 

Ensure that your investment decision is based on the quality of the investment and not just the tax aspect.

 

Paying a tax free capital dividend makes sense. Why? It removes money from the corporation into the personal hands of the recipient on a tax free basis. If this is not done, the money remains in the corporation and possibly subject to creditors or a lawsuit. We cannot think of any reason why dentists would not remove such money from their corporation on a tax free basis. If the corporation is short on cash, it could pay this tax free dividend to the individual. This individual could then lend the cash back to the corporation on a secured basis (i.e. if there is a lawsuit etc. against the company, this could “protect” money which was previously unprotected). There is no cost/downside to the dentist/family members when he/she receives this tax free capital dividend.

 

What is a capital dividend? It represents half of the capital gains generated by your private corporation. Prior to your private corporation paying a tax free capital dividend, one should communicate with the tax department to verify the Capital Dividend Account balance. This could take one to two months.

 

  1. Federal small business tax rate

 

What has the government announced?

The Federal small business tax rate will be lowered:

  • 0.5% decrease from 10.5% to 10% effective January 1, 2018
  • A further 1% decrease from 10% to 9% effective January 1, 2019

 

As a result of the above, the combined Federal and Ontario provincial corporate tax rate for taxable income from an active business up to $500,000 will decline from the current rate of 15% to 14.5% effective January 1, 2018 and 13.5% effective January 1, 2019 for all professional, hygiene or technical service corporations.  If your corporation’s fiscal year-end is other than December 31, then the new corporate rate will be pro-rated based on the period before and after these effective dates.  These rate changes do not apply to, or affect the taxation of investment income in the corporation.

 

What does this mean for you?

There is a greater tax deferral from having a corporation. A tax deferral means paying taxes later as opposed to sooner. A tax deferral exists because the corporation is paying a lower tax rate than the individual’s personal tax rate of up to 53.53%.

 

What should you do now?

If you have not already done so, consider setting up a professional/hygiene/technical corporation to take advantage of the tax deferral. Speak with your tax advisor to determine whether it makes sense for you to have a corporation as it would depend on your individual goals and financial situation.

 

This article is intended to present tax savings and planning ideas, and is not intended to replace professional advice.

 

David Chong Yen, CPA, CA, CFP is a tax specialist who has been advising dentists on tax, estate, financial planning, valuations and accounting for more than three decades. In addition to being a speaker at various dental schools, associations across Ontario, the Toronto Academy of Dentistry Winter Clinic, ODA Annual Spring Meeting and RCDSO Road Shows, David has published hundreds of tax articles for the dental community, and wrote the ODA-published book titled, Dentists’ Tax and Financial Guide. David may be contacted at david@dcy.ca.

 

Louise Wong, CPA, CA, TEP is a tax specialist. Her practice is restricted to taxation, estate and divorce issues, purchases and sales of dental practices. She has been serving dentists for more than a decade. Louise may be contacted at louise@dcy.ca.

Basil Nicastri, CPA CA is a tax specialist and has been serving the dental profession for more than a decade. Basil may be contacted at basil@dcy.ca.

 

Choy Men Lin, CPA, CA, MAcc is a tax specialist and has been serving dentists for more than a decade. Choy Men may be contacted at choymen@dcy.ca.

 

Eugene Chu, CPA, CA, MAcc has been serving dentists for more than a decade. He has co-authored several articles which have appeared in various dental publications. Eugene may be contacted at eugene@dcy.ca.