While there are about 8,500 dentists in Ontario, only about 4,500 of them have dentistry professional corporations. Why do dentists incorporate? And what’s the holdup for other dentists?
Incorporating a dental practice is done mainly for tax purposes. You can defer paying taxes by having the corporation only pay 15.5% on the first $500,000 of active business income and then leaving the after-tax dollars inside the corporation. You can income split by using your immediate family (e.g. spouse, children). You can also sell the shares of your dentistry professional corporation and pay little or no taxes by using and multiplying your lifetime capital gains exemption (currently $750k).
But what else should you know about when it comes to incorporating? Well, let’s look at the not-so-often discussed points.
When someone creates a corporation, they are essentially creating another person. That person can own their own assets, take on their own debt, be sued and sue others, etc. Importantly, they are owned by people who hold shares in the corporation (i.e. certificates evidencing ownership). Now, when it comes to the liability of the shareholders for the debts and obligations of the corporation, the liability of shareholders is said to be “limited”. In other words, their personal assets are not exposed to the debts and obligations of the corporation. It’s the corporation’s assets that are exposed to being used to pay off creditors and others.
To reiterate, under the Business Corporations Act, the shareholders are generally not liable for any act, default, obligation or liability of the corporation: section 92(1). There are certain exceptions to this general rule. For example, courts have lifted the corporate veil to impose personal liability on shareholders in certain cases, which I have previously blogged about (e.g. fraud, lack of respect for corporate form, alter ego, thin capitalization, etc.). Furthermore, there may be statutory impositions of liability on shareholders under the Business Corporations Act.
So what about dentistry professional corporations? Does the same general rule of limited liability apply? Well, when it comes to professional liability, the answer is “dentist’s liability is UNLIMITED”. Section 3.4(1) of the Business Corporations Act says very clearly that section 92(1) does not limit the professional liability of a shareholder of a professional corporation. The Act even goes on to say that the shareholder’s acts (and the acts of the employees, officers, and directors) are deemed to be the professional corporation’s for the purposes of professional liability (section 3.4(2)). No doubt, these provisions were put in place to protect the public from bad dentists who incorporated their practice to avoid liability for malpractice. Heck, even if the dentistry professional corporation is a member of a partnership, the shareholder of that corporation cannot escape professional liability.
Now, what about liability for things that are unrelated to professional liability? Well, the Act doesn’t address those matters directly. But if you take sections 3.4(1) and 92(1) together, it would appear that dentist shareholders have limited liability for things unrelated to professional liability. This could include entering into a commercial lease and defaulting on the lease, taking out and then defaulting on a bank loan, hiring or terminating staff inappropriately, and leasing equipment and then defaulting on that lease. Basically, anything that the dentist would do in the context of running a business and not necessarily providing professional dentistry services COULD essentially give the dentist limited liability as a shareholder of the corporation. In any event, dentists should take caution when entering into these types of legal agreements (e.g. leases, loans, employment agreements, etc.) and should also have insurance in place if things go awry.
Small Business Tax Rate
Not every dentist should be incorporating their practice. Only if they make a certain amount of income each year, have family members to split their income with, or are thinking about selling their practice should they then think about doing it. Not only are there many procedural hurdles to cross along the way to getting incorporated, but it also costs money: legal and accounting fees. It also takes time to set up the corporation, get a bank account, roll over existing assets to the corporation, have the corporation assume the obligations of the practice (e.g. lease, loans, employees, etc.), etc.
One thing worth mentioning is the small business tax rate for small business corporations. With a corporation, the first $500,000 of active business income is taxed at a much lower rate than for individuals: it was (combined federal and provincial) only 15.5% for 2011. So what does this mean for dentist shareholders? Well, instead of having to claim all their practice’s income in a given fiscal year, they can leave it in the corporation, pay less tax, and then either reinvest it or dividend it out to shareholders – particularly those who are in lower income tax brackets. This all ends up deferring or saving taxes altogether!
Personal Services Business Problem: AVOID THIS ONE!
So how could a dentist lose out on this 15.5% tax rate and end up getting charged the much higher (the regular) tax rate for a corporation? Well, the Income Tax Act has a whole bunch of rules related to denying Personal Services Business corporations the tax advantages of incorporating. The idea is that if an employee associate of a dentist simply incorporates and continues to provide services to the dentist through their corporation, then the corporation will not benefit from the small business tax rate of 15.5%.
So what is a Personal Services Business corporation? It gets complicated, so just follow me for a second.
First, a Personal Services Business corporation carries on business where an individual (i.e. a human being) performs services on behalf of the corporation. In the typical situation, an associate dentist would incorporate their practice, and their dentistry professional corporation would in turn be hired by a dentist to provide dental services. For its part, the dentistry professional corporation would engage the associate to provide those services to the dentist on its behalf (the associate is called an INCORPORATED EMPLOYEE). Remember: there are three persons involved at this point: (1) a dentist (who hires the dentistry professional corporation), (2) a dentistry professional corporation that is hired to provide services and which in turn engages the associate to perform those services and (3) an associate (i.e. the INCORPORATED EMPLOYEE) who provides services to the dentist on behalf of or for the dentistry professional corporation (because a corporation cannot do anything without human actors!).
Now, we’re just getting started with the tax rules, so pay attention. A Personal Services Business Corporation is a business that has one of these INCORPORATED EMPLOYEES performing services to a dentist through the corporation. But the INCORPORATED EMPLOYEE must also be a SPECIFIED SHAREHOLDER of the Corporation. What does that mean? Well, a SPECIFIED SHAREHOLDER is someone who owns at least 10% (directly or indirectly) at any time in the given year of the issued shares of any class of the capital of the corporation.
Employee of the Dentist
Now, just when you thought we were done with these tax rules which deny Personal Services Business Corporations from qualifying for the small business income tax rate for corporations (15.5%), there’s one more requirement that applies: the Incorporated Employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided (i.e. the dentist who needs the associate) but for the existence of the corporation. What does this mean? Basically, if the Incorporated Employee – had they not incorporated a dentistry professional corporation – reasonably been regarded as an employee, then their dentistry professional corporation will not qualify for the small business tax rate of 15.5%.
Now, even though we have to look at a number of things to determine whether the dentistry professional corporation of the associate would qualify for the small business tax rate of 15.5%, there is an exemption. If the dentistry professional corporation employs throughout the year more than five full-time employees, then it will not be considered a Professional Services Business Corporation! Sounds good, but that means you have to fork over a lot of money to full-time employees to qualify! Ouch! I guess the government figured that if you’re employing at least five full-time employees (plus yourself, so it’s actually six), then you’re more legitimate as an independent business and not just an employee in disguise.
So what is the rationale for limiting the small business tax rate by saying that Personal Services Business Corporations aren’t entitled to it? Well, it has to do with fairness: Personal Services Business Corporations are merely a way of disguising an employment relationship but allowing the dentistry professional corporation to take advantage of favourable income tax rates. That’s why they are not allowed to benefit if the above rules are true. What does this mean for dentist associates? BE CAREFUL when you’re asked to incorporate as an associate independent contractor. You might not get to take advantage of the favourable tax rates and rules that go hand in hand with typically having a corporation!
If you are an associate dentist who has been asked to incorporate their practice as an independent contractor to provide services to one dentist, then you may be considered a personal service business (and not entitled to favourable income tax rates and rules) if:
- You perform the services to the dentist on behalf of your corporation;
- You own 10% or more of any class of shares of your corporation;
- Without the use of your corporation, you would be considered an employee of the dentist; AND
- Your corporation has fewer than six full-time employees.
There are other, more complicated and intricate tax rules, but you can get the gist of it by reading the above. In the next blog, I’ll discuss what factors the Canada Revenue Agency considers relevant when trying to determine whether an associate would reasonably be regarded as an employee of a dentist instead of as an independent contractor.