Professional Corporations – Tax Implications

The following is a brief summary of the tax savings and other tax implications of using a professional corporation.  Since tax laws are complex and change from time to time, if you are considering incorporating your medical practice or other professional practice we recommend you work with a tax accountant.

Eligible for Small Business Deduction

  • Corporations pay lower tax rate on income eligible for small business deduction
  • The small business deduction must be shared between associated corporations
  • Ontario small business deduction benefit may be lost if associated corporation has taxable income
  • Claw-back applies even if associated corporation does not earn active business income (e.g. owns rental assets)

Tax Deferral vs Tax Savings

  • Professional may choose to be compensated by salaries or dividends or a combination thereof
    • Ask your accountant to provide you with a comparison of extracting income as salary vs dividend
  • Tax deferral available if professional leaves income to be taxed in corporation at small business rates
  • Tax savings available if professional leaves income eligible for federal small business deduction to be taxed in corporation, and receive after tax amount as dividends
  • Tax savings disappear if higher income retained in corporation, but can still defer personal tax on dividends
  • The decision as to whether higher income should be retained in the corporation will depend on the cash flow requirements of the professional. The longer the professional plans to leave earnings in the corporation, the more valuable the potential deferral may be
  • Over time, the benefit of tax deferral may far exceed the ultimate tax cost

Capital Gains Exemption

  • Professionals can claim capital gains exemption if shares of professional corporation sold
  • Surplus assets should be removed to ensure corporation qualifies as small business corporation at all times
  • Ability to claim the capital gains exemption may be restricted if professional has claimed investment expenses in excess of investment income (i.e. has a CNIL account), or has claimed certain types of losses (capital loss, allowable business investment loss) in the past
  • Corporation may pay dividends to professional to neutralize CNIL account

Work In Progress

  • Professionals are allowed to elect not to include any amount in respect of work-in-progress of the year into income
  • WIP has no cost for tax purposes
  • On the transfer of assets to the professional corporation, the professional will be able to elect to transfer the WIP at its cost amount
  • Professional corporation receives same tax treatment for WIP

Income Splitting

  • Income-splitting with family members possible for Doctors and Dentists
  • Unknown whether family trust will be permitted to be shareholders
  • Family members who are shareholders may receive dividends from corporation
  • Family members who are not active in the business may receive dividends
  • Family members who are active in the business may receive a combination of salaries and dividends
  • Family members may realize capital gains on sale of shares of corporation
  • Family members may be eligible to claim capital gains exemption on capital gain realized on the sale of shares
  • Corporate attribution rules may apply if practice transferred to a corporation that spouse or family trust (if permitted) is a shareholder, and corporation is not a small business corporation
  • Professional will be deemed to have received interest on value of assets transferred to corporation
  • Corporation will not be able to deduct deemed interest payment
  • Spouse/family trust also taxed on any dividends received from corporation
  • Double taxation may result
  • Corporate attribution not applicable if both spouses are active in business (i.e. transfer of assets to corporation by one spouse not done to benefit the other spouse)
  • Corporate attribution rules may be avoided if corporation is a small business corporation at all times
  • Surplus assets should be removed to ensure corporation is a small business corporation at all times
  • Consistent with requirement that professional corporation can only have temporary surplus assets
  • May continue to use the following income splitting techniques:
    • Reasonable salary to spouse/other family members
    • Management corporation/partnership owned by spouse
      • Separate small business deduction available to management corporation
      • Use of trust with minor beneficiaries as shareholder of management corporation may cause corporations to be associated 

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