Overview
Members of the College of Physicians and Surgeons of Manitoba are given the opportunity to incorporate their practice. Like every other Canadian province and territory, Manitoba allows medical professionals to carry on their practice and provide services through a professional corporation. Although the applicable statute refers to these corporations as “health profession corporations,” in this article we will refer specifically to “medical corporations” incorporated by physicians.
Most corporations do not have any restrictions concerning their activities, directors, officers or shareholders. However, medical corporations are different because they are regulated by specific legislation. In Manitoba, ownership of voting shares of a medical corporation is restricted to physicians or other medical corporations and ownership of non-voting shares is restricted to physicians or spouses/common-law partners and children of physicians, or corporations owned by those individuals. Only a physician may be a director of a medical corporation and the president of the medical corporation must also be a physician.
Finally, the activities that may be undertaken by a medical profession are restricted to the practice of medicine and the provision of services directly associated with that practice (although a medical corporation may also have passive investments, including real property other than for the purposes of development). Applicable legislation appoints the College of Physicians and Surgeons of Manitoba to oversee the profession and determines the specific rules applicable to said corporations.
Many medical professionals incorporate their practice and there are certain advantages in doing so. However, there are also drawbacks that need to be carefully considered and their impact will depend on each individual situation. The size and nature of a medical practice and the medical practitioner’s family situation are only a couple of the factors that may affect the decision of whether to incorporate.
This article provides an overview of the benefits and the disadvantages of incorporating a medical corporation and other matters to consider when planning to incorporate. Similar rules to those described in this article also apply to dental corporations and other health profession corporations.
Tax Deferral and Accelerated Savings
One of the most important advantages of creating a professional corporation is that the individual professional will be able to defer personal income tax. In Manitoba, income produced by the active business of the corporation, such as income from a medical practice, is taxed at corporate income tax rates, which are lower than personal tax rates. Where the small business deduction is available to the corporation, the corporation’s income in Manitoba is taxable at the rate of 9% (combined provincial and federal tax) on the first $500,000 of earnings. Active business income not eligible for the small business deduction is still taxable at a lower rate compared to personal income. By retaining a portion of a practice’s income in the corporation, a professional will defer paying personal income tax until a later date when the funds are withdrawn (e.g. as dividends, salary or bonus) and tax is paid personally on those funds.
While there is an advantage in keeping money in a corporation to be withdrawn at a later date, hence having more after-tax money for investments, it is important to recognize that in Canada’s tax system, the concept of integration is intended to eliminate any advantages and disadvantages in the application of tax between individuals and corporations. The concept is that the same income should be taxed at the same rate regardless of whether it is earned by a corporation and then paid out as a dividend to an individual shareholder by the corporation or if it is earned by the individual directly. Depending on the applicable tax rates, there may be a slight tax cost to earning income through a corporation followed by a distribution of after-tax profits paid to an individual shareholder by way of a dividend, absent any benefit of deferral within the corporation.
On establishing a medical corporation, a physician will become shareholder of the corporation, with the entitlement to receive dividends, and could also become an employee, whose salary is paid by the corporation. The shareholder is then in the position to be able to adjust the amount of money personally received by them each year based on their personal needs, while retaining more after-tax money to invest in the corporation and to be withdrawn when needed. If the funds are used for retirement planning, they can be withdrawn at a time in the future when a person is at a lower personal income level which means that less taxes may eventually be payable at that point.
One issue to consider is that as a result of changes contained in the 2018 Federal Budget, the small business deduction is reduced (and may be eliminated completely) where a corporation (or corporations in its associated group) earns passive investment income. Manitoba adheres to the federal measures limiting the small business deduction where a corporation has passive investment income between $50,000 and $150,000 in a taxation year, for tax years beginning after 2018, with no small business deduction being available where passive income is in excess of $150,000.
If they want to benefit from tax deferral, medical professionals must consider whether enough earnings can be retained in the corporation in each fiscal year, as the tax advantage may not justify the increased operational costs of the corporation. There are the initial set-up costs of setting up the corporation, for instance, legal fees, and annual legal and accounting fees for the corporation. Further, as mentioned before, integration is an imperfect concept as it does not always yield an exact after-tax result when earnings are paid as salary or dividends. Overall, professionals must bear in mind that if all funds are withdrawn every year from the corporation, they are likely going to bear a higher overall tax rate compared to earning directly.
Your accountant can help determine if you will be retaining enough earnings in a potential corporation.
Income Splitting
Prior to 2018, by incorporating their practice, professionals could benefit from income-splitting opportunities. Family members with lower earnings could subscribe for shares of the professional corporation, being in the position to receive dividends and taking advantage of their potential lower marginal tax rates. Manitoba, like a number of other provinces, requires that the voting shareholder of the medical corporation be a physician or another medical corporation, but non-voting shares can be held by a spouse, common-law partner, or child of the voting shareholder. By having family members with lower individual marginal rates subscribe for non-voting shares and receive dividends on those shares, the family’s overall tax bill had the potential to be lower than if all dividends were paid to the physician alone.
Reliance on this strategy has been reduced, and in most cases eliminated, by the expansion of the “tax on split income” (TOSI) rules which came into effect on January 1, 2018. Generally, dividends paid to family members by a medical corporation are taxed at the highest marginal rate, reducing the ability to split income. There are some exceptions to TOSI, which must be considered when tax planning for professional corporations. One applicable exception is where the family member shareholder is actively engaged in the business on a regular, continuous, and substantial basis either in the current year or any of the five preceding years. This level of engagement is usually associated with an average of 20 hours per week work in the professional corporation. If this test is met, TOSI will not apply to dividends paid to that shareholder.
If the physician is over the age of 65 and splits income with their spouse (or common-law partner), regardless of the age of the spouse or common-law partner, the TOSI rules will also not apply to dividends received by the spouse or partner. This exception only applies to the professional’s spouse or common-law partner and does not apply to children.
One income-splitting option available to the corporation in instances where the family member does not meet the active engagement requirement is to pay them a salary commensurate to their involvement in the business. Wages received by the family member do not fall under TOSI rules and are deductible by the corporation as an expense. Salaries received must be reasonable for the services provided by the family member, being an amount equivalent to what a third party would receive for the same engagement in the business.
Other Tax Planning Opportunities
When creating a corporation, professionals will have the opportunity to remunerate themselves in various forms, through salary, dividends, or bonuses. By creating a remuneration plan that fits one’s lifestyle and family needs, a professional will have the opportunity to decide the amount to leave in the corporation, hence benefitting from tax deferral, while also being able to maximize their contribution entitlements to RRSPs for each tax year or to contribute to other benefit pension plans through tax-deductible contributions made by the corporation, which will not be captured by the limits for passive investment mentioned above.
Furthermore, certain expenses that are not related to the business and non-deductible, such as payment of insurance premiums, can still be paid by the corporation. Corporate earnings are taxed at lower rates, requiring less pre-tax income to pay these expenses.
Money sitting in the corporation can also be loaned to the shareholder on a short-term basis, with interests that are lower than financing the debt through other lenders. A shareholder loan is not taxable when money is withdrawn from the corporation, although there are specific rules to keep in mind and caution must be exercised when loans are made to a shareholder by a corporation. The loan must be properly documented by the corporation and interest must be charged at a rate that it is at least equal to the CRA’s prescribed rate at the time the loan is made (this rate changes quarterly and is 5% for the fourth quarter of 2023). The loan must be repaid within one year from the end of the taxation year of the corporation in which the loan is made, otherwise, the amount will be added to the shareholder’s income in the year in which the loan is made.
Lifetime Capital Gains Exemption
One major benefit that a professional may receive from incorporating their business is the lifetime capital gains exemption (LCGE), which is available to Canadian residents when selling shares of a qualified small business corporation. The LCGE is indexed annually and for 2023 there is a lifetime exemption of $971,190.
There are a few factors to consider when assessing the eligibility for LCGE. For instance, the Income Tax Act requires that 90% of corporate assets be used in active business when shares are sold, and generally the shareholder must have been the owner of the shares for at least 24 months prior to the sale. The most direct consequence is that the business might not be eligible for LCGE when large sums have been accumulated throughout time for investment purposes, as 50% or more of the assets must have been used in an active business the prior two years. It should also be noted that physicians are generally very limited in the opportunities to sell their corporations, as a physician will often not be able to sell their corporation unless it owns an active business other than their personal practice, such as owning a medical clinic. The LCGE, however, might be claimed on the death of a physician where they die owning the shares of their medical corporation.
Liability
Shareholders of a corporation are in general not personally liable for the corporation and its debts unless they have provided a personal guarantee. However, medical corporations are somewhat unique in that incorporating does not shield against all personal liabilities as it does not limit the professional liability for a physician, for instance, for professional negligence or malpractice. By statute, physicians are individually responsible for negligence, and professional responsibility is in no way lessened by the fact that a physician is providing services to patients through a medical corporation.
Increased Complexity and Increased Administrative Costs
When incorporating a business, many businesspersons are surprised at the higher costs and increased requirements to run their business. There are legal fees and administrative fees that go with the incorporation process. The corporation will need separate bank accounts and corporate credit cards and it will need to file its own tax returns, all factors which could potentially lead to higher accounting expenses.
The corporation itself is also subject to additional regulatory requirements. There are annual meetings of shareholders and directors to be held, and proper paperwork must be prepared and included in the minute book of the corporation. Dividends or any other movement of money must be properly documented, each year the corporation must file annual returns with the Companies Office, and notice of certain changes in the corporation must be provided to the Companies Office and the College of Physicians and Surgeons of Manitoba.
Estate planning
One last matter to consider when incorporating is estate planning. Discuss with your professional advisors your wishes on death for your professional corporation and the tax consequences on death of owning shares in a professional corporation. For instance, when shares of a professional corporation, or any corporation, have increased in value, taxes are generally paid by the estate of the deceased on the capital gain realized on the death of the shareholder.
Does it make sense for you to incorporate?
If you are considering incorporation of your medical practice, please reach out to one of the members of our Health Care group.