Proposed Tax Changes to Private Corporations: More Questions Than Answers

September 25, 2017

 

The federal government’s proposed tax changes for private corporations continue to draw debate during this 75-day public consultation period ending October 2, 2017.

After this date, the government will determine its next steps. In particular, it will decide whether or when to introduce the bill in Parliament. MD Financial Management is closely monitoring this process and will continue to provide updates on next steps.

Take action now

It’s important to let the government know how these proposals will impact your situation as an incorporated physician. If you haven’t already, please participate in the consultation and share your thoughts on these proposed changes with the federal Department of Finance before October 2.

Submissions can be sent to fin.consultation.fin@canada.ca. The Canadian Medical Association (CMA) is planning to make a submission on behalf of its members and has created an electronic letter that physicians can personalize and send directly to their member of Parliament.

What these proposed changes could mean for incorporated physicians

Although no legislative changes have been introduced yet, the government’s proposals, if enacted as written, may impact the way physicians approach tax planning. More specifically, the proposed changes could affect their decision about whether to incorporate their practice going forward.

Here’s a quick look at what the proposed changes could mean for physicians who are considering incorporation, for those who are already incorporated and for retired physicians.

Are you considering incorporation?

If the proposed changes are enacted as written, they will constrain or eliminate the two primary tax reasons why physicians incorporate their medical practice: income sprinkling and tax deferral.

Currently, incorporated physicians can reduce their family’s overall tax bill by splitting their income with family members through dividends. The proposed change will subject family members to a reasonableness test, measuring their contribution—whether it’s time spent working for the practice, or their contribution of funds to the practice. If the reasonableness test is not met, the family members could be taxed on their dividend income at the highest marginal personal tax rate. 

As for tax deferral, the proposal includes a framework under which investment income would be taxed at a significantly higher rate, reducing the ability to use a corporation to enhance retirement income. However, an incorporated medical practice will still benefit from the preferred small business tax rate (approximately 15% at present), creating an opportunity to invest and save in the corporation.

If you are considering incorporation, it may make sense to wait until there is more concrete information about these proposals from the federal Department of Finance to review against your particular circumstances and your objectives before deciding whether to incorporate. 

Do you already have a medical professional corporation?

Under the proposed changes, you may be faced with some tough choices. Should you take advantage of your last chance for dividend sprinkling under the current rules, or should you keep your capital in the corporation to maximize your tax-deferred growth?

Here’s an example to help explain this challenge. Let’s say you have an 18-year-old daughter who is a shareholder in your medical professional corporation and about to start university. In anticipation of the new dividend sprinkling rules becoming law, you might consider drawing a dividend equal to the full four years of school costs from the corporation this year. That payment would typically eat into the retained earnings of your corporation. 

But here’s the dilemma: the government has said the tax proposals will allow for grandfathering of existing corporate investments under the old investment rules. This means that your retirement savings may have more opportunity to grow by being retained in the corporation before any new passive investment deferral rules might take effect. In this scenario, you’d have to choose between helping your daughter and maximizing your retirement income.

With income sprinkling changes proposed to take effect January 1, 2018, you may want to review your income sprinkling opportunities and the potential consequences for your retirement plan close to the end of this year.

Are you retired with a corporation?

For retired physicians with a professional corporation, the grandfathering rules on existing investments held within a corporation might allow you to avoid any consequences of the proposed tax changes, unless new dividend sprinkling rules apply. If you’ve concentrated your wealth in your corporation and plan to use dividend sprinkling in retirement, you will likely need to watch the proposed changes more closely than those physicians who have diversified wealth that includes other income-splitting options.

Should you do anything with your private corporation at this point?

We understand the uncertainty and confusion around these proposed changes, but it’s important to remember that these are just proposals, not yet law. Not only are the rules not yet set, if you take action prematurely, you may harm a pool of capital that you can’t replace. And because the proposals are planned to be effective at different dates, you may need to reconsider your tax strategies and retirement several times.

We continue to review and analyze these proposals and will share any additional information as it becomes available. In the meantime, please speak with your MD Advisor if you have any questions about your financial plan or are considering new strategies.

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