In my previous articles, the benefits of incorporating a business have been discussed at length. The tax advantages for corporations are substantial enough that some taxpayers structure the financial relationship with their “vendors” so that they are deemed self-employed, thus qualifying to operate as a corporation earning active business income. This allows the corporation to deduct expenses otherwise not deductible and qualify its corporate profit to the low corporate tax rate (currently 13.5% on the first $500,000 in British Columbia).
There are some professions where CRA recognizes the practitioner as self-employed with very little resistance. One of these professions is the medical profession in British Columbia. Many medical doctors and specialists have their own practice. These practitioners are obviously self-employed and most professionals are incorporated to take advantage of the Canadian tax structure.
On the other hand, many doctors provide their expertise exclusively to one hospital. Although the relationship between these doctors and the hospitals that “employ” their services fit the employee/employer relationship definition provided by the CRA, these practitioners are still recognized as self-employed by CRA. These medical practitioners generally have a “contract for service agreement” with the hospital which CRA accepts as evidence of self-employment.
Many medical practitioners, particularly young practitioners, may find it unnecessary to incorporate on the onset. They likely need to repay student loans and deal with the high cost of home ownership in Vancouver, and a young family may not provide for much left over for tax deferral opportunity within the corporation. Although this is likely true, opportunities still exist to lower the tax burden in these situations.
One obvious tax planning tool is the income splitting tool. If the practitioner’s spouse earns a much lower income or is a stay home spouse raising young children, allocating dividends to the spouse can create huge tax savings. A spouse can hold non-voting shares of a medical practice corporation. Adult children needing funds to attend college can also be allocated non-voting shares as well. As long as share classes and share holdings are structured properly initially, undesirable legal issues can be minimized and tax planning opportunities optimized.
A more advanced tax planning tool would be to set up a holding company that would hold the shares of the incorporated medical practice. Shares of the holding company would be issued to the medical practitioner. Shares can also be issued to the spouse and the adult children to allow for the dividend sprinkling strategy discussed above.
Another bonus to having a holding company in the tax planning structure is the ability to credit-proof the retained earnings. Since medical practices can be vulnerable to professional negligence law suits and creditors claims, removing retained earnings out of the incorporated medical practice to a holding company may provide some protection.
So the flow of profits would be as follows: retained earnings from the incorporated medical practice can be paid out as dividends to the holding company tax free as long as the two corporations are “connected” which would be the case in the majority of the time. Then these funds in the holding company can be paid out to the practitioner and other members of the family as dividends to spread the tax burden. The funds retained in the holding company can then be invested for growth. The funds can be drawn out in the near or the distant future. Either way, much taxes have been deferred and possibly avoided in the future due to the good planning.
See my blog post Tax Planning for Corporate Retained Earnings for more details.
In a later article, I will discuss the use of a trust to add more flexibility and avoid potential problems when adult children are direct shareholders of a company.
If you have any questions or would like to know more about how we can help you, contact us.
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