Understanding Integration and Investment Taxation for Corporations

August 1, 2017

 

IMPORTANT NOTICE: Professional medical corporation information on MD’s web site is based on existing incorporation rules which may be impacted by proposals announced in the Department of Finance’s policy paper entitled “Tax Planning Using Private Corporations.”  MD is monitoring these proposals and we will update our tax planning strategies accordingly should rules change. For more details, please read MD’s blog Tax Planning Using Private Corporations, What’s Next: A Summary of Finance Announcements

Every financial situation is unique and therefore requires unique advice. For the incorporated physician, taxation can be an even more complex issue to address as it relates to compensation and investment income.

Here are some general considerations that help in managing the investment tax challenge when you have a corporation.

Asset location: The basic premise of asset location is to be judicious about which account or accounts you use to buy investments with different income or tax characteristics. All else being equal, there is an investment tax bias as follows:

  • Avoid interest-generating investment within a corporation
  • Target growth investments where the purpose is to accumulate investments most effectively
  • Target Canadian dividend investments where the priority is income distribution opportunities

Notional accounts: Notional accounts are used to track special characteristics of different types of corporate investment income. Your tax advisor will keep tabs on these notional accounts, but you should check in periodically to determine whether balances in your general rate income pool (GRIP) account, refundable dividend tax on hand (RDTOH) account or a capital dividend account (CDA) can be used to improve your compensation strategy. Your MD Advisor can provide a table to demonstrate these tax calculations.

Tax protection: A variety of products and structures can help in managing corporate tax on investment income. The characteristics and value of this protection can vary considerably. Some, like an individual pension plan (IPP), help by shifting assets outside the corporation to a sheltered plan. Others, like life insurance, can create tax protection within the corporation.

TFSAs: Combining long time horizons with corporate investment income taxation often means a TFSA could result in material tax savings. This approach relies on a compensation strategy that will result in surplus personal funds and a lower retention of surplus assets within the corporation. Your MD Advisor can help you determine whether this strategy might work in your situation.

Integration tax and investment tax

Our tax system aims for “integration,” meaning the total tax payable should be the same regardless of whether you draw salary or dividends. However, integration is not always perfect and there can be a minor tax advantage or cost to earning income through a corporation, both for income from your medical practice and for investment income.

Integration tax—Cost/benefit on active business income: The following table conveys the integration advantage or cost of earning active business income through a corporation for 2017:

 

 

 

Tax Rate1

Convert

Province/Territory

Gap

$100,000

British Columbia

-0.70%

-700

Alberta

-0.60%

-600

Saskatchewan

0.60%

600

Manitoba

-1.00%

-1,000

Ontario

0.00%

0

Quebec

-0.90%

-900

New Brunswick

-0.30%

-300

Nova Scotia

-0.10%

-100

Prince Edward Island

-0.90%

-900

Newfoundland and Labrador

0.10%

100

Yukon

0.10%

100

Northwest Territories

2.00%

2,000

 

 

1 Tax rates used to compute these values are the combined effective top federal and provincial tax rates for 2017 as of May 1, 2017. Please note that physicians practising in Nunavut are not eligible for incorporation.

As shown, the cost benefit of paying dividends as opposed to salary varies by province. In Quebec, for example, the cost is 0.9% of compensation. On $100,000 per year of practice income distributed to a recipient in Quebec’s top tax bracket, the resulting current cost of paying dividends (rather than salary) is $900 per year.

Notably, the integration gaps are based upon corporate income eligible for the small business rate, assume the top personal tax bracket provincially, and do not include payroll factors, such as health taxes and Canada/Quebec Pension Plan (CPP/QPP). They also do not factor in “extra” current taxes—which could be considerably higher—paid due to lost registered retirement savings plan (RRSP) room and/or lost ability to use health plans.

Investment tax gaps

The integration tax cost/benefit table above on active business income demonstrates that there are gaps in integration. Similarly, there are also gaps between the tax a corporation pays on investment income and the tax that would be paid by an individual earning investment income directly at the top tax bracket.

 

Tax Rate2

Convert

Province/Territory

Gap

$100,000

British Columbia

-4.50%

-4,500

Alberta

-5.00%

-5,000

Saskatchewan

-3.80%

-3,800

Manitoba

-6.20%

-6,200

Ontario

-2.40%

-2,400

Quebec

-1.70%

-1,700

New Brunswick

-5.50%

-5,500

Nova Scotia

-7.00%

-7,000

Prince Edward Island

-7.40%

-7,400

Newfoundland and Labrador

-6.30%

-6,300

Yukon

-5.60%

-5,600

Northwest Territories

-1.20%

-1,200

2 Tax rates used to compute these values are the combined effective top federal and provincial tax rates for 2017 as of May 1, 2017. Please note that physicians practising in Nunavut are not eligible for incorporation.

As the table above shows (using British Columbia as an example), $100,000 of interest income would result in about $4,500 of additional tax in a corporation, compared with personal tax at the top tax bracket. Obviously, the investment tax problem is even greater when contrasted with RRSP or tax-free savings account (TFSA) structures that shelter or eliminate investment tax. Remember, a dividend compensation strategy will eliminate RRSP contribution room.

Your MD Advisor and tax advisor can help you navigate the complex issues of integration and investment taxation for incorporated practices.

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How Provincial Variations and Non-Tax Issues Can Impact Your Compensation and Income as an Incorporated Physician

IMPORTANT NOTICE: Professional medical corporation information on MD’s web site is based on existing incorp...

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Compensation: The Salary vs. Dividends Decision

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