Last week we looked some tax benefits Your lawyer, doctor, and other professional clients can look forward to forming a professional corporation. In this article we will look at two key disadvantages and address a number of other factors taken into account when deciding on inclusion.
The two most significant disadvantages are:
#1. All corporate partners must share the $500,000 Small Business Development Fund (SBD). If the specialist is currently working with other entities, the tax benefits of the SBD may be lost, particularly if the partnership as a whole generates net income well in excess of the $500,000 threshold.
Read: When family businesses merge
#2. Costs. Professional fees are necessary to establish and maintain a corporation. In addition, annual income tax compliance costs arising from filing a corporate tax return, T4 pay slips and T5 dividend slips will increase.
Other considerations
Other issues to consider when deciding whether to incorporate an apprenticeship:
Flexibility: Corporations offer professionals more flexibility than unincorporated practices. For example, in the case of a corporation, you can choose any tax year end, while in the case of an unincorporated company, income must be reported on a calendar year basis.
Moreover, in a corporation, a professional has the choice between accepting salary and dividends as compensation. For unincorporated businesses, profits are taxed as business income on the owner’s tax return.
Load: One of the traditional benefits of forming a corporation that many owners of a professional corporation do not have is protection from personal liability in the event of professional negligence. Professionals should contact their regional or territorial regulatory authority for details of their particular situation, but the general rule is that in the event of professional misconduct, the shareholder (professional) will be personally liable. There may be limited personal liability arising from other types of creditor attacks on the corporation (i.e. non-professional liabilities such as trade liabilities, office lease liabilities and bank loans that have not been personally guaranteed).
Investing inside corporations
The tax benefits of a professional corporation are best when profits can be left in the corporation and taxed at lower rates. This, of course, raises the question of what to do with those profits.
Most often, the remaining cash will be invested within the corporation. It is important to consider the tax rates that apply to any intra-corporate investment income because the small business deduction will not apply to this investment income. Interest income will be taxed at the highest corporate income tax rate (up to 50% of the combined federal and provincial tax rate, which varies by province), capital gains at half that rate, and portfolio dividends received from taxable Canadian corporations (called also portfolio dividends). at a flat rate of 33.33%.
Other things to consider when investing inside a corporation:
- Increased Capital Gains Exemption: If the owner’s goal is to claim lifetime capital gains exemption at some point in the future, it will be important to keep a close eye on the amount of investment within the corporation. If too much is held within a corporation, it is possible for the corporation to become tainted for purposes of this exemption. It is important to work with a tax professional to ensure that the corporation still qualifies for the exemption.
- You should review your regional laws and regulations and the bylaws of each professional governing body to understand what investment activities are permitted in the corporation and whether investing in the corporation is permitted at all. This is of particular interest in Ontario, where provincial regulations stipulate that investment activities cannot be at such a level as to constitute a separate activity. This doesn’t mean you can’t make any investments in a corporation: the rules also say it’s okay to temporarily invest surplus funds. While a reasonable interpretation might be that it should be OK to passively invest excess funds in GICs, stocks, mutual funds or segregated fund contracts, this is an area that requires careful case-by-case analysis.
- If a professional wants to keep investments outside the corporation, this can be done in a tax-efficient way.
If permitted, you can set up a holding company and pay dividends from your professional company to the holding company tax-free.
In provinces where holding companies are prohibited from owning shares in professional corporations (because only members of the profession can be shareholders), a separate management company may be formed and the companies may collect fees to pass profits to the management company. The remaining profit in the management company can then be used for investment purposes. Please note, however, that GST/HST charged by a professional corporation’s management company may not be reclaimed by the professional if he or she cannot claim the input tax credit.
summary
Incorporation may not be a feasible option for all professionals. If a professional needs all of his or her profits to fund everyday living expenses, it may not be the time to incorporate a corporation because the costs of collecting a salary or dividends – as well as forming and maintaining a corporation – may exceed any tax advantage. However, when a professional finds himself in a situation where some profits may be left in the corporation for taxation, incorporation can provide significant tax deferral benefits.
