December 1, 2005
by Peter J. Merrick, BA, FMA, CFP, FCSI
In Canada today there are more than 17,000 dentists. Many of these professional men and women turn to accounting, financial and legal professionals to help them legally structure their companies and financial affairs to achieve three glorious outcomes: wealth preservation, legal tax avoidance and creditor protection.
Of these three glorious outcomes I have always been fascinated how many times I have met very smart and successful practicing dentists who have neglected to put in place strategies that creditor proof what they have spent a life time to build. Too late in the process, I see stumble into my office owners of incorporated businesses who have personally guaranteed loans for their practices/companies or non-incorporated dentists who have left themselves personally exposed to creditor attacks. If only they had invested the time and money structuring their financial affairs in such a way that their money would have stayed in their pockets, and not in the pockets of someone else. When it comes down to creditor protection; an ounce of prevention is worth more than a pound of cure.
I have always promised myself that, given the opportunity and time, I would write a primer/checklist of successful strategies that business owners and their accounting, legal and financial professionals have put into action to ward off creditors. By no means is this a complete list of creditor proofing solutions. I invite you to forward some of your ideas that I have failed to mention in this article.
Note: The strategies listed below provide protection from creditors but they will not provide protection against professional liability, negligence and misconduct. I highly recommend before applying any of these strategies, that you consult with the proper financial, accounting, legal professionals and provincial regulating bodies to find out if they work for your particular situation.
The problem in Canada is that proprietorship and partnership businesses in Canadian law are seen and deemed to be the same legal entity as the person and people who own and operate them. This means that creditors can sue the owners of these types and business structures and take aim at their personal assets such as their homes, investments, and RRSPs.
When a business is incorporated under Canadian law it is considered a separate legal entity from the individual or individuals who own the incorporated business. What this means is, if an incorporated business is sued successfully, the personal assets of the business owner/s are protected from creditors in most situations. It should be noted that dentists who create a professional corporation in many cases are not able to shield their assets in their companies if they are found professionaly liable for professional misconduct or negligence.
Create a holding company
Holding companies may be placed between shareholders and their operating companies for reasons of taxation and legal protection. The income in the operating company remains subject to a lower tax rate using small business deductions. Dividends may be paid from the operating company to the holding company at a preferred tax rate to build up assets in the holding company, keeping the active company mean and lean, free from creditor intrusions.
The strategy of creating a holding company to own an operating company works perfectly for a dental technical corporation that is owned by a holding company. In the future, with the changes in provincial legislation, all dental professional corporations across this country may be permitted to be owned by holding companies.
Avoid signing personal guarantees
The main reason one chooses to incorporate his or her business is to segregate his or her personal assets from his or her corporate assets and liabilities. If one signs a personal guarantee for corporate debt he or she voids this separation from business and personal assets and the creditors of the business can successfully attack personal assets.
Create an Inter-Vivos Trust (Living Trust)
A living trust is created while a person is alive. This type of trust enables a person to control the distribution of their estate while they are alive. An individual is able to transfer ownership of his or her property into a trust. A revocable living trust is a vehicle that is very helpful in avoiding probate and completing an estate freeze.
In some cases non-revocable trust assets that are transferred to the trust may remain available to creditors. However, a living trust will make it much more difficult for creditors to have access to the assets of the trust. Creditors will first have to petition the court for a changing order to be able to attack the assets held in the trust.
Make sure the ownership of personal property is in a spouse’s or in grown children’s names
When the ownership of personal assets is in a spouse’s or grown child’s name, these assets are separated from the business owner’s assets and liabilities. Creditors will not be able to attack assets of a spouse or grown child, provided that the spouse or grown child are not directors or guarantors for either the business or personal debt of the contributing spouse.
Make shareholder loans to become a secured creditor
An owner of an incorporated business can make shareholder loans back to his or her company becoming a secured creditor, having first rights to corporate assets if the company has debt and other financial troubling issues.
In some provincial jurisdictions RRSPs are creditor protected. However, it is a wise strategy for a business owner to consider making part or all of his or her RRSP contributions into a Spousal RRSP. The business owner will take the tax deduction and the asset becomes the spouse’s property. Creditors will not be able to attack the assets of the spousal RRSP provided that the spouse is not a director or guarantor for either the business or the personal debt of the contributing spouse.
Purchase investment and retirement products through insurance companies
Investment products held in insurance companies such as RRSPs, universal life policies, segregated investment funds and annuities may be protected from an individual’s creditors if the named beneficiary of these insurance products is a spouse, parent, or grandchild of the annuitant, or if the named beneficiaries on these insurance products are irrevocable.
Create individual pension plans and retirement compensation arrangements for business owners
Incorporated business owners who have a T4 income of over $100,000 per year should consider creating a “super charged RRSP” in the form of an Individual Pension Plan (IPP) or a Retirement Compensation Arrangement (RCA). Contributions to these two vehicles exceed the maximum allowable RRSP limits, are fully deductible by a company and are a non-taxable benefit for the beneficiaries of these plans. Assets held within the IPP or RCA cannot be seized by creditors of a incorporated business. IPPs and RCAs offer significant amounts of additional tax-deferred income to be set aside for a business owner’s retirement which could protect hundreds of thousands and even millions of dollars from corporate creditors.
Create a Health & Welfare Trust (HWT)
Incorporated business owners should consider creating a Health & Welfare Trust for themselves. A HWT is a bank account whose deposits are spent exclusively on health-care expenses. By having an HWT, business owners
may convert health-care expenses into 100 percent business deductions and a nontaxable benefit for him or herself. All monies deposited into a HWT are only to be used for healthcare expenses therefore these monies are segregated from both personal and corporate assets and are immune from creditors.
For all Canadians subjected to personal liability as a result of their professional activities, creditor protection is absolutely critical. A wise person is someone who does not live in fear of the worst-case scenario but is aware of it and has prepared to the best of his or her ability to prevent or lessen it from happening. Spending the time putting strategies into place today to ward off creditors of the future just makes good business sense. Just remember, all the creditor proofing in the world with the best legal, accounting and financial advice will not prevent in cases of divorce from an ex-spouse to have claim to 50 percent of the family assets, no matter how good the creditor proofing planning has been.
Peter Merrick, BA, FMA, CFP, FCSI is the President of Merrick Wealth Management Inc., a boutique fee-for-service executive benefit and financial consulting firm in Toronto. He is also a professor of financial planning and employee benefits in programs that lead to the Certified Financial Planning and the Certified Employee Benefit Specialist designations in Toronto. He is currently writing his first book entitled “Individual Pension Plans — A RRSP Upgrade” due to be published in the spring of 2006. Peter can be contacted at firstname.lastname@example.org