March 1, 2002
by Ron MacKenzie
According to Bill 152, which received Royal Assent on December 21, 2000, dentists (and other specified professionals) will soon be able to incorporate their professional practice in Ontario.
According to the proposed legislation, only members of the dental profession will be able to hold shares of the incorporated dental practice. This is similar to the Alberta model where only members of the Alberta Dental Association can hold shares. On the other hand, in British Columbia, while only the members of the College of Dental Surgeons of British Columbia can hold voting shares, specified family members can hold non-voting shares. This has permitted the use of income splitting through dividends and family trusts. This will not be the case in Ontario. However, Ontario dentists should consider incorporating their dental practices. There are many advantages and disadvantages to incorporating your dental practice.
1.The incorporated dental practice tax rate (at 19.58% in Ontario) on the first $200,000 of net income is significantly lower than the top marginal personal tax rate (46.41% in Ontario in 2001). While this seems attractive at the outset, when the retained earnings (accumulated after corporate tax profits in the incorporated practice) are subsequently distributed to the dentist as dividends, they will be taxed at the dentist’s top marginal tax bracket at the time. However, dividends, due to a dividend gross up and tax credit mechanism, attract personal income tax at a rate approximately 15% less than ordinary income such as bonus, wages or unincorporated dental practice profits. In effect, the total tax paid at the end of the day whether it is earned through an incorporated dental practice, or an unincorporated dental practice, is approximately the same. However, there is a tax deferral (not a savings), which will permit a larger pool of cash to be used for investment purposes within the incorporated dental practice. Each province has its own provincial tax rate.
2.As a result of the above advantage, the amount available for investing corporately is significantly greater each year when the investments are made by the incorporated dental practice. The incorporated dental practice can invest in any type of instrument which an individual can (securities, bonds, property, etc.). Due to compounding, the nest egg at the end of the investment cycle will be substantially more than had identical investments been made personally with after personal tax rate dollars.
3.By incorporating your dental practice, and by meeting certain requirements, you will be able to sell the shares of the incorporated practice and claim an exemption from capital gains tax on the first $500,000 of capital gains. I have discussed this in previous articles. Basically, the shares must be Qualified Small Business Corporation Shares (QSBCS), and you must meet certain personal tax requirements (CNIL and ABIL balances should be nil or low). There is also a 24-month test that must be met. Or, if the practice has not been incorporated for twenty-four months, there is a provision that permits this requirement to be waived. These are complex matters that should be discussed with your consultant or accountant.
Since the dentist purchasing the shares of your dental practice will be buying a non-depreciable asset (shares as opposed to assets such as equipment, leaseholds, etc.), the result will be that the purchaser pays more taxes in the future because he will be able to claim less depreciation. However, it is possible to calculate the present value of those future extra taxes which normally results in an 8-10% discount of the fair market value of the purchased assets to determine the fair market value of the shares of the company holding only those assets. Again, complicated matters but you should become aware of them. This is also one of the key advantages to incorporating. Demographically, many dentists in Canada will be retiring within the next few years. Be informed.
4.You will be able to transfer term life insurance personally held into the company. The benefit is that the premiums, which are non-deductible whether paid personally or corporately, can be paid by the company without it being considered a taxable benefit to you. The benefit is that the premiums are paid with after corporate tax rate dollars, rather than top marginal personal tax rate dollars. The beneficiary becomes the company, which would receive the proceeds tax-free and would be added to the corporation’s Capital Dividend Account (CDA). Distributions from the CDA would be received tax-free by the estate. Again, check with your legal advisors to make sure the situation meets your will and other legal requirements. All that is required in order to implement the plan is for you to write a letter to the insurance company assigning the policy and changing the beneficiary.
5.Unless you are asked to personally guarantee company liabilities (i.e. the premise lease, bank loans, etc.), your personal assets cannot be attached upon default by the
company. While this is unlikely, the possibility does exist. Your professional liability is unchanged when you incorporate.
1.One of the main disadvantages is that you will be required to include in your income, in the year that you transfer your practice to the corporation, your remaining reserve. In 1995, all unincorporated professionals with other than a December 31 fiscal year end were required to bring a specified amount into their income in that year, and each of the subsequent nine years. We are now approximately one-half of the way through the cycle and many unincorporated professionals have a substantial reserve yet to be included in their income over the next several years. However, incorporating your dental practice will cause the remaining reserve to be brought forward into your income at the time of incorporation and the transferring of your practice. Check with your accountant to see how much your reserve is, and estimate the personal income taxes payable. For example, if you incorporated and transferred your practice in (through a tax free rollover election) during 2001, the additional personal income taxes as a result of the reserve being brought forward would be payable on or before April 30, 2002. However, by deferring the transferring in of your practice until 2002, the incremental personal income taxes would be deferred until April 30, 2003. Cash flow timing is important. It is important to know, however, that transferring your practice does not create new taxes. These taxes would have had to have been paid in the future in any event (we are assuming that your personal tax brackets would be more or less the same).
2.When you incorporate your dental practice, you will likely be required to assign your premise lease from your unincorporated practice (Dr. Dentist) to the incorporated practice (Dr. Dentist Inc.), which may trigger an assignment provision within your premise lease. Review it carefully and follow the instructions with your lawyer. In some cases, some leases indicate that a request for assignment can firstly trigger a termination by the landlord, if the landlord wishes. If your premise lease has such a provision, an informal request, and then a formal written acknowledgment from the landlord that such a provision will not be triggered, is prudent. However, you must request the assignment. If you don’t inform your landlord, then you have probably caused the premise lease to be breached. I have written enough about these problems in the past for you to understand my concern.
3.There are certain professional costs (legal, accounting and consultant) that are required. However, this is a significant point in your professional career and must be handled properly. The process should be kept simple yet effective. For example, these are the steps that we follow when we assist dentists in the incorporating process:
Evaluate the dental practice assets being transferred into the new corporation (required for the tax-free rollover election).
Work with the accountant or lawyer in preparing the tax free rollover election.
Review certain personal tax data to ensure the reserve and other amounts are properly calculated and taxes estimated.
Work with the lawyer in preparing the incorporating documents and the authorized and issued share capital.
Review the Premise Lease for potential problems and resolution of them. Review possible relationship with any Technical Service Corporation.
On balance, you should consider incorporating your dental practice. The advantages far outweigh the disadvantages. However, make sure you understand the process, and do it properly. It may come under review from the Canada Customs and Revenue Agency, your landlord and other parties.
Ron MacKenzie, B. Comm., CA, is the principal of MacKenzie & Company, CAs and practice consultants to the dental community.
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