The 13.5% Corporate Tax Rate
I have discussed or referenced in many corporate tax planning blogs that the biggest benefit to being an incorporated Canadian business is that the first $500,000 in corporate profits is taxed at a low 13.5% corporate tax rate. Professionals and their net profits from an incorporate practice also benefit from this corporate tax rate.
Tax Planning Problem for Professional Partnerships
However, many professionals work in a partnership business structure where service revenues, operating costs, and professional liabilities are being shared under an agreed upon partnership agreement. The tax planning problem for professional partnerships is that the $500,000 limit is available to the entire partnership, not each partner individually. In other words, all of the incorporated partners have to share the $500,000 limit taxed at the favorable 13.5% rate. For example, in a law practice that has five partners, with each partner being incorporated (which is the common scenario in real world), each corporate partner is not eligible for the $500,000 limit at the favorable tax rate. The $500,000 limit is instead allocated to the five partners, likely under some partnership agreement and not necessarily equally. Any one partner’s share of the partnership’s net profit in excess of his share of the allocated $500,000 limit amount is taxed at the higher corporate tax rate of 26%.
Basically, incorporated professionals who practice as members of populous partnerships have historically enjoyed very limited tax benefits from incorporating…but not all is lost!
Not All is Lost!
Nowadays, many partnership agreements are structured in such a way that the financial risks are not being shared, as one would expect in a partnership. In fact, each partner is essentially on their own, networking to find and service their own clients, and the “partnership” is nothing more than a cost sharing agreement and an outlined process on how to remunerate various stakeholders.
Qualify Each Partner for the $500,000 Limit at the 13.5% Corporate Tax Rate
If partnership agreements are structured in such a way that risks and benefits are not being shared, this allows each partner to claim that her practice is independent and would therefore qualify each partner for the entire $500,000 limit at the 13.5% corporate tax rate. In order to strengthen this claim, partnership agreements and service agreements must be in place and worded in such a manner to demonstrate that each practitioner/partner conducts their own practice independent of the others.
The 13.5% corporate tax rate on the first $500,000 in profits creates many other tax planning and wealth management opportunities for the practitioner, and therefore it is worth structuring partnership agreements in ways that allow each partner to qualify for the entire $500,000 amount rather than sharing it amongst each other.