July 1, 2007
by David Chong Yen, CFP, CA
SUBSEQUENT TO THE PUBLICATION OF MY LAST ARTICLE (TAX POLICY CHANGE = TAX BITE) WHICH APPEARED IN THE SPRING 2007 ISSUE OF DENTAL PRACTICE MANAGEMENT, OUR HONORABLE FEDERAL FINANCE MINISTER PROPOSED, ON MARCH 19, 2007, TO REVISE THE LIFETIME CAPITAL GAINS EXEMPTION (CGE) TO $750,000, EFFECTIVE JANUARY 1, 2008 (FROM $500,000).
As a transitional measure for 2007, your CGE will be capped at $625,000 for dispositions occurring from March 19, 2007 through December 31, 2007 (for a maximum personal tax savings of about $145,000).
If you co-own a dental practice with one or more dentists, how should you structure the ownership? What are your options? Is one option more tax efficient than others? Here are the most common structures used among dentists in Ontario.
A dental/hygiene/technical partnership is an association or relationship between two or more dentists, or professional/ hygiene/technical corporations who join together to carry on a dental/hygiene/technical practice. Each dentist or respective professional corporation (dentist) contributes money, labor, property, or skills to the partnership and in return, is entitled to a share of the profits/losses (revenue minus expenses) of the practice. The profits/losses are usually divided among the dentists based on the percentage or formula specified in the partnership agreement. The partnership does not pay income taxes; it is the dentists who report the profit and pay income taxes on their own share of the profit.
With a partnership, you should make every effort to ensure a partnership agreement is properly prepared and signed among all parties. This agreement should provide an avenue to resolve all future arguments or mishaps, for example, profit sharing, new patient allocation, death, disability, bankruptcy, departure, admission of new partners, buy/sell and dissolution of partnership. The shortcomings of a partnership include the joint and several liability i.e. the lender or creditor can recover the whole indebtedness of the partnership from any one partner.
There may be significant tax saving opportunities available to each corporate partner as a result of the ability to multiply the amount of income each partner can earn which will be taxed at 18.62%. There have been several Advance Tax Rulings (“ATR”) issued by the Canada Revenue Agency which deal favorably with this issue (i.e. income assigned to each professional corporation of the partner; each professional corporation is entitled to the low corporate tax rate of 18.62% on the full $400,000). ATRs are issued based on specific facts raised by that particular taxpayer and so far no court case of this nature has been tested. Consult your tax professional to review your own situation to ensure that each partner will be entitled to the $400,000 low corporate tax rate.
In 2000, when a professional corporation was first permitted in Ontario, only dentists were allowed to be shareholders of dentistry professional corporations. As of January 1, 2006, a dentistry professional corporation can include dentists and their family members as permitted by legislation. It remains that only dentists can be the director of a dentistry professional corporation. A dentistry professional corporation is a separate legal and tax entity. However, it must abide by the rules and regulations under the Royal College of Dental Surgeons of Ontario, and must also seek authorization from the College prior to its business operation.
As mentioned above, effective January 1, 2006, spouse, children and parents of dentists are permitted to be shareholders of a dentistry professional corporation. However, in-laws, cousins, nephews, brothers, sisters, grandparents and grandchildren of dentists are not permitted to be shareholders of a dentistry professional corporation. There is no limitation to the percentage of shares your non-dentist family members can own in your dentistry professional corporation as long as you (the dentist) own all the voting shares. This fact is of great tax significance as the dentist could structure the professional corporation such that non-dentist family members retain the most valuable portion of the professional corporation (dental practice).
With a hygiene/technical corporation (TSC/HSC), the hygiene or technical service profit (i.e. income minus expenses) of the practice is taxed in a separate corporation. Anyone including brothers, sisters, uncle, aunt, niece, nephews and in-laws as well as a holding company may become the shareholders of this corporation. To allow full flexibility in income splitting, it generally involves a family trust as the shareholder of TSC/HSC. Anyone can be a beneficiary of the family trust. The trustees of the family trust have full discretion as to which beneficiaries receive dividends and how much in any given year.
The TSC/HSC enters into a contract to provide hygiene/ technical services to the dentist and his/her patients. The T/HSC buys its own equipment, supplies, etc. pays its share of the overhead including salaries and opens its own bank account.
If the practice is operated as one corporation, in which you, other dentists and the respective family members are shareholders of this particular corporation, there must be a clear consensus as to how dividends/salaries could be paid to each party. That is why you need to have a shareholders’ agreement to govern any unforeseen events e.g. buy/sell, option to purchase, disability and death. With several dentists owning one corporation, that means only the first $400,000 profit generated by the corporation would benefit from the low corporate tax rate of 18.62%. Any remaining corporate profit in excess of the $400,000 threshold would be taxed at 36.12%.
Cost sharing is not a legal entity and it does not have to file any tax return or pay any taxes. Each cost sharing participant (i.e. dentist or corporation) basically operates their own practice independently. The increased popularity is due to the tax and commercial advantages of being a sole proprietor rather than a partner. However, it is not without its own problems e.g. GST issue or the CRA could allege that it is in fact a partnership. The essence of a cost sharing arrangement must be the sharing of expenses rather than profit. If the cost sharing participant is a corporation, it should have its full $400,000 of profit being taxed at the low corporate rate of 18.62%. That means each cost sharing participant could enjoy the low tax rate of 18.62% on the first $400,000 of taxable income i.e. the low rate threshold is multiplied.
There are advantages and disadvantages for each option; which one best suits your needs depends on your goals and circumstances. Please consult your advisors before making your final decision as to which option best suits your needs.
David Chong Yen, CFP, CA with an international firm background and more than twenty-seven years of experience, advises healthcare professionals and owner-managers. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail email@example.com. This article is intended to present tax saving and tax planning ideas and is not intended to replace professional advice.