October 4, 2017
by David Chong Yen, CPA, CA, CFP; Louise Wong, CPA, CA, TEP; Eugene Chu, CPA, CA
Is this the end of professional corporations?
It’s been over a decade since the government allowed non-dentist family members to become shareholders of a dentistry professional corporation (DPC). Just as the government gives, it can also take away. The introduction of new sweeping tax changes is causing frustration among many dentists and essentially reverses many of the benefits that were provided to dentists and their families back in 2006, when dentists were given the ability to include their families as shareholders of their PC. Let’s take a look at the key changes that are causing dentists and their accountants many sleepless nights.
One of the primary advantages of allowing family members to become shareholders of a DPC was to income split and reduce the family’s overall tax bill. Two individuals with an income of $100,000 each would pay significantly less taxes than one person with an income of $200,000. The government is looking to impose a reasonableness test on any salary or dividends paid to family members. The government would have the ability to assess what a family member should be paid based on the amount of work and amount of capital they have put into the DPC. Failing this test means the monies paid to family members would be taxed in their hands at the highest tax rate, effectively eliminating any tax savings benefit.
Multiplying the Capital Gains Exemption
The same reasonableness test is being applied to capital gains. In this case, despite your family members legally owning a certain percentage of shares, the government has the right to deem the monies they receive from the sale of their DPC shares to be unreasonable. Failing the reasonableness test in this situation means that the family member would be ineligible to claim the lifetime capital gains exemption (LCGE). This would increase their tax bill by up to $220,000 upon the sale of the DPC shares. There are some tax maneuvers that can be done to lock-in some tax savings, but in many cases action needs to be taken before December 31, 2017. It’s advisable to speak to your accountant immediately to see if you need to take action.
Additionally, where minor children are equity shareholders, it results in a tax trap unless the practice is sold by December 31, 2018. After this date, minor children would be forced to report the capital gain upon sale of their shares with no access to their LCGE. As an example, if a minor child owned equity shares since birth 10 years ago, and those shares were worth $1 million today, that child could not use any LCGE upon the sale of their shares. Even if the sale of the shares occurs after they turn 18, the increase in value up to the age of 18 would not be eligible for the LCGE and any increase in value after they turn 18 would be subject to the reasonableness test. Effectively, the tax is being applied retroactively and all the gains that were supposed to be tax-free are now subject to taxes.
Taxes on Investment Income
The government’s attack on private corporations doesn’t end at income splitting. They also want you to pay taxes faster by eliminating tax deferral benefits of investing money in your DPC. Details have not yet been revealed, but the new tax changes on how passive income (i.e. monies earned on investments where you don’t have to sweat) will be taxed mean you can no longer use your DPC as a super-sized RRSP.
Transfer of DPC Share to a DDS Child
It’s not all bad news, but it’s not exactly good news either. The government has announced it’s looking for feedback to allow for a win-win situation where there is a legitimate transfer of a business to a child. This would mean the parent could claim the LCGE on the sale of their shares to a child and the child could use a DPC to buy the shares allowing them to use cheap corporate dollars to repay the loan. The reason it’s not good news yet, is that there are no concrete plans in place currently to allow it; instead the issue is simply open for discussion. Based on the tax proposal, an intergeneration succession plan may be negatively taxed. In other words, it’s going to get worse before it gets better.
Is There Any Advantage of a DPC?
With both the benefits of income splitting and deferral of taxes on investment income being eliminated, it begs the question whether a DPC is still worth having. In many regards, the tax changes which allowed DPCs in the first place, and subsequently those that allowed non-dentist family members to be shareholders changed the dental industry significantly. The market for dental practices grew exponentially as DPCs became tax efficient vehicles for buying and selling dental practices. It allowed many dentists to invest in their practices and build up self-managed retirement/pension funds to provide for themselves and their families. It also contributed to the proliferation of dentists owning several practices, reinvesting profits taxed at low rates in to other dental practices thereby generating employment for Canadians as well as serving the disadvantaged, including those on social assistance programs. There were many positive changes from the introduction of the DPC and these new proposed tax changes are a major step back for the DPCs and private corporations in general. There’s still a place for DPCs especially for those looking to purchase and sell dental practices and there’s still value in being able to dictate the timing of one’s personal income. Things could still change, 2019 is an election year after all.
This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.
This article was prepared by David Chong Yen, CPA, CA, CFP, Louise Wong, CPA, CA, TEP and Eugene Chu, CPA, CA of DCY Professional Corporation Chartered Accountants who are tax specialists* and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail email@example.com / firstname.lastname@example.org / email@example.com. Visit our website at www.dcy.ca.