A Bag Full of Tricks: Government Disappoints Bay Street
Summary of Corporate Tax Measures Effective for 2006 Tax Year

Using Professional Corporations To Provide Services

The main legislation governing Professional Corporations (PCs) are sections 3.1 to 3.4 of the Ontario Business Corporations Act (OBCA).  The OBCA defines a PC as “a corporation incorporated under this Act that holds a valid certificate of authorization or other authorizing document issued under an Act governing a profession”.  Accordingly, depending on the profession in which you practice direct reference must be made to the governing body legislation and regulations.  For example, lawyers should refer to the Law Society of Upper Canada and the Law Society Act.

For income tax purposes, section 248 of the Income Tax Act (1995 Amendment) defines a professional corporation as “a corporation that carries on the professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor”.  Further, Interpretation Bulletin 189R2 entitled “Corporations Used by Practicing Members of Profession” provides CRA’s policy on when to recognize a professional as carrying on business through a PC.

A professional corporation must satisfy the following conditions before being incorporated under the OBCA:

1.         All of the issued and outstanding shares of the corporation shall be legally and beneficially owned, directly or indirectly by one or more members of the same profession.

2.         All of the officers and directors of the corporation shall be shareholders of the corporation

3.         The name of the corporation shall include the words “Professional Corporation” or “Societe professionelle” and shall comply with the rules respecting the names of professional corporations set out in the OBCA regulation.  Name must also comply with rules of the governing body.

4.              The corporation cannot be a numbered company

5.         The articles of incorporation of the professional corporation must be worded to prevent the corporation from carrying on business other than the practice of the profession.  Certain activities that are “related to or ancillary” to practices are permitted.  For example, investment of surplus funds earned by the corporation, or holding real estate.

However, with respect to medical professionals, the requirement that all shareholders must be members of the same profession has been relaxed.  Effective January 2006, the Ontario government amended the legislation for the medical profession to permit family members of physicians to become non-voting shareholders of the professional corporation.  Trust for minor children can also hold shares in the corporation.  These changes have not been made for lawyers or accountants.

One of the main benefits of setting up a PC are the tax deferral opportunities.  If the individual tax rate of 46.4% is compared to the small business rate of 18.6% the tax savings of 27.8% is immediate if money is earned by a PC.  On distribution the effective tax rate on the dividends is 31.3%, which results in an integrated rate of 44.1% that is 2.3% lower than the individual tax rate.  By 2007, with the increase in the small business limit to $400,000 shareholders of eligible PCs would save approximately 3% in taxes. 

Although ownership is restricted for lawyer professional corporations to practicing professionals, in unique situations a shareholder in a professional corporation may be able to income split.  For example, two-lawyer spouse families can income split with a professional corporation because both would be “members of the same profession” as required under the OBCA.  Not clear if a firm partnership agreement or cost sharing arrangement will prohibit this, however, it does not appear, at least in the case of the Law Society of Upper Canada that this is a problem from the regulatory standpoint. 

Another opportunity to income split, may occur as a result of proposed changes in law.  The Minister of Finance has hinted toward changing taxation of spouses to one unit.  If this proposal goes forward, then it will likely eliminate the need to implement income splitting strategies between spouses.  It is not clear how changing the family to a single unit taxpayer will change the tax rates for individuals but presumably it will be more favourable than the current tax rates for families with one income earner.

Other benefits income the opportunity to establish a pension plan in a PC.  Contributions will be made to the pension plan instead of to an RRSP.  The age of the professional and the age of the professional’s spouse will determine whether there is an advantage.  Managing an individual pension cost will have increased administration costs. Also, where the professional owns another company that has been experiencing non-capital losses, these losses can be used to shelter losses from professional practice subject to the debt forgiveness and acquisition of control rules.  In addition, where life insurance premiums are non-deductible, since the tax rate is lower for a PC than and individual, the cost of non-deductibility will be lower for the corporation than the individual. 

Further, there is an additional advantage when PCs pay a bonus to shareholders.  This benefit arises because individuals are required to have a fiscal year end whereas corporations can choose to have non-calendar year-ends.  This will permit a tax deferral on the bonus declared to an owner manager.  This primarily seems to be based on rule 78(4) of the Income Tax Act (Canada) where a bonus must be paid within 180 days after the tax year for which it is incurred.  For example, if a PC year end October 31, 2007 and a bonus is paid April 16, 2008 (within 180 days after tax year end) then the bonus is deductible to PC in 2007.  The shareholder will receive the bonus in 2008 but does not have to report it on personal tax return on June 15, 2009.

Copyright ©


Feed You can follow this conversation by subscribing to the comment feed for this post.

The comments to this entry are closed.