Dentists want to know: “How do I take money out of my dentistry professional corporation tax free?” Well, here is one way to do it…just bear in mind the risks! Basically, a shareholder of a dentistry professional corporation can take a tax-free loan from the corporation and pay no tax on that loan for up to two (2) years – so long as the loan is eventually repaid and the shareholder doesn’t create a habit of using this technique!
To understand how this all works, we’ll start off with section 15(2) of the Income Tax Act:
The Bad News: Taxes!
Section 15(2) says:
15 (2) Where a person (other than a corporation resident in Canada) or a partnership (other than a partnership each member of which is a corporation resident in Canada) is
(a) a shareholder of a particular corporation,
(b) connected with a shareholder of a particular corporation, or
(c) a member of a partnership, or a beneficiary of a trust, that is a shareholder of a particular corporation
and the person or partnership has in a taxation year received a loan from or has become indebted to the particular corporation, any other corporation related to the particular corporation or a partnership of which the particular corporation or a corporation related to the particular corporation is a member, the amount of the loan or indebtedness is included in computing the income for the year of the person or partnership.
So this section basically says that, if a person is a shareholder or is “connected” with a shareholder of a dentistry professional corporation and receives a loan from that corporation, then the amount of that loan MUST be included in that person’s income for the year (and hence tax must be paid on it). Here, the word “connected” is defined in s 15(2.1) to include person with whom the shareholder does not deal at arm’s length with (which includes your spouse and children).
The Good News: No Taxes if…
Thank God for Section 15(2.6)! This section says that a shareholder loan will NOT need to be included in the shareholder’s income for the year if it is repaid within one (1) year from the end of the corporation’s taxation year and if the repayment is not part of a series of loans or other transactions and repayments.
Take the following example. The fiscal year end for Dr. Michael Smith Dentistry Professional Corporation is December 31, 2013. That corporation loans Dr. Michael Smith (the shareholder) $100,000 on January 1, 2014 (i.e. the next day). Now, so long as the loan and repayment are not part of a series of loans or other transactions and repayments AND it is repaid on or before December 31, 2015 (yes folks, that’s about 2 years after the loan was originally provided), then Dr. Michael Smith would NOT need to include that amount in his income taxes!
The Canada Revenue Agency Interpretation Bulletin (IT-119R4) on shareholder loans helps explain what is meant by a “series of loans or other transactions and repayments”:
¶ 28. It is a question of fact whether or not a repayment of a loan is part of a series of loans or other transactions and repayments. In most cases, when there are only a few loans or other transactions and a few repayments made during a taxation year of a lender, there is no such series. However, when only one loan or other transaction and one repayment occur in each taxation year of a lender, a series of loans or other transactions and repayments may still be in evidence. This could occur, for example, when a repayment is of a temporary nature, such as a loan that is repaid shortly before the end of the year and the same amount, or substantially the same amount is borrowed shortly after the end of the year. Such a repayment of a temporary nature is not considered to decrease the loan balance in applying subsection 15(2) and paragraph 20(1)(j) to a series of loans or other transactions and repayments. (see ¶s 34 to 36 below).
The underlined sentence in the above paragraph essentially means that, if Dr. Michael Smith was to take out the aforementioned loan and repay it before December 31, 2015 and then shortly thereafter take out “substantially the same amount” after December 31, 2015, then the Canada Revenue Agency may deem such transactions to be “a series of loans or other transactions and repayments” – for which Dr. Michael Smith would need to include the amount as income under s. 15(2) and pay income taxes. So the bottom line is this: focus on loan and repayment timing, loan amounts, and not making a habit of it! This strategy would enable a dentist shareholder to take out a tax-free loan from their dentistry professional corporation: the amount would not be included as income, nor would any taxable benefit arise from paying no or inadequate consideration.
And always be sure to speak with your accountant about this maneuver.