10-Jan-1999
On January of this year the Nova Scotia Legislature passed the Medical Professional Corporations Act, which permits doctors to incorporate their medical practices. However, the regulations needed to allow incorporations to proceed were not approved by Cabinet until the end of August. With the approval of these regulations, any doctor practising in Nova Scotia can now incorporate his or her medical practice.
All doctors should consult their professional advisors to assess the pros and cons of incorporating their particular practice. Some of the advantages and disadvantages are outlined below.
Income Tax Savings Through Incorporation:
Doctors in Nova Scotia now pay income tax at graduated rates that reach approximately 50% on taxable income over $77,000.
On the other hand, a company carrying on an active business pays income tax of only 18% on the first $200,000 of its taxable income. Although personal income taxes must also be paid when this income is paid out of the company to the doctor, there is a potential tax saving of approximately $8,800 annually by earning $200,000 of income in a corporation and then paying any after-tax amounts out to the doctor as dividends. If the company pays the doctor a salary of $100,000 and dividends of $100,000, there is still a tax saving of approximately $4,400. Payment of a salary is advantageous because salary income qualifies as “earned income”, thereby allowing the doctor to make an annual RRSP contribution.
Comparable savings as a percentage of income are achieved for doctors who earn substantially less than $200,000 per year, and doctors with practices having a net income of less than $100,000 may still benefit from tax savings through incorporation.
To qualify for this favourable tax treatment, the company must carry on an active business. Most medical corporations should qualify as an “active business”, provided the company does not own substantial 'passive' investments, such as rental properties or portfolio investments.
Additional savings can be achieved if some of the earnings of the medical corporation are not immediately required by the doctor, as these can be left in the company, thereby deferring payment of personal income taxes.
The favourable income tax treatment for a medical corporation applies only to the first $200,000 of its net income in any year, and net income over $200,000 will be taxed at a much higher rate. However, it is always possible to keep the company's income at $200,000 or below by increasing the amount of salary paid to the doctor (which reduces the company's income). For practices carried on as a partnership, the partners must share the $200,000 low-tax bracket. This will make incorporation less attractive for members of a large partnership, unless the partnership is dissolved and the practice is continued as a cost-sharing arrangement. In that case each doctor can enjoy a separate $200,000 low-tax bracket.
Income Splitting:
Under the rules of the Medical Professional Corporations Act, a majority of the shares of an incorporated practice must be held by a doctor. However, shares can be held by non-practitioners, including members of a doctor's family. This may create the potential for income splitting, by placing some shares in the hands of the doctor's spouse and/or children. This form of share structure may allow dividend income from the company to be taxed in the hands of the family members rather than the doctor, thereby splitting income and lowering the overall tax burden on the doctor's family. One or more family trusts can be used in this structure to increase flexibility, particularly in the case of doctors with young children. Doctors who wish to use income splitting strategies should consult with their professional advisors to ensure that the strategies comply with the requirements of the Income Tax Act.
Limited Liability:
Because a company is a legal entity which is distinct from its shareholders, an advantage of incorporation is the restriction of the liability to which the shareholders would otherwise be exposed, if they carried on the business as a sole proprietorship or partnership. For many businesses, this limited liability is often an important reason for incorporating, quite apart from the income tax benefits described above. The Medical Professional Corporations Act places substantial restrictions on the limited liability status of a doctor's company: the doctor will still be subject to the regulatory control of the College of Physicians and Surgeons, and will still be personally responsible for professional negligence claims. However, it may be possible to shield a doctor’s practice from other types of liability, unless the doctor personally guarantees the obligations of his or her company.
Some Disadvantages of Incorporation:
Prior to 1996, doctors and other professionals were allowed to 'defer' one or more years' income taxes by reporting their practice income on a non-calendar year basis. This deferral has now been abolished, but as a transitional measure professionals are permitted to bring the deferral into income gradually, over a ten year period. Any doctor that incorporates will lose the benefit of this transitional provision. This could mean the prepayment of taxes in 1996 and 1997 that would otherwise only be due in annual instalments to 2005. However, it may be possible to minimize or manage the impact of this prepayment of taxes for some medical practices: this will depend on the financial position of the practice at the time of incorporation.
Other disadvantages of incorporation include the costs of incorporating a company and additional corporate filings and tax returns that must be completed on an annual basis. A company also reduces the flexibility that a doctor, as an owner, may have with respect to taking loans from his or her practice. Once incorporated, all shareholder loans must adhere to the strict limitations imposed by the Income Tax Act.
There are also other taxes that must be considered in structuring a medical corporation, such as the alternative minimum tax, deed transfer taxes and the G.S.T. However these are usually not significant barriers to incorporation.
The information contained in this Client Update is intended for general information only. For further information on the incorporation of medical practices, please contact any member Corporate/Commercial group.
Stewart McKelvey Stirling Scales
Suite 900, Purdy’s Wharf Tower One
1959 Upper Water Street
P.O. Box 997
Halifax NS B3J 2X2
Telephone: 902.420.3200
Facsimile: 902.420.1417
E-mail Address: smss.com
