In July 2017, the Minister of Finance released draft legislation with the stated intention of curtailing certain tax planning strategies that were common practice for many Canadian business owners, including incorporated health professionals. After a brief consultation period and extensive public backlash, some of the proposed measures were dropped and others were tweaked.
In December 2017, the Minister released a technical backgrounder and new draft legislation to amend the originally proposed adjustments to the income splitting rules; however, most of the proposed measures restricting “income splitting” between an incorporated health professional and their family members, remained and are expected to be applicable commencing for the 2018 taxation year.
The ownership structure for most health professional corporations were put in place to allow the professional to income split by paying dividends to family members 18 years of age, or older. Under the new tax rules, this type of “income splitting” will generally only be permitted for health professional corporations where it can be demonstrated that the dividend recipient:
- Is 18 years of age or older and has worked in the practice at least 20 hours a week in the year or any of the previous five years and didn’t receive fair market value remuneration for their labour efforts; or
- Made a “meaningful contribution” to the practice in the current or a previous year and did not receive fair market value compensation for their efforts. A “meaningful contribution” to a business can be demonstrated through a labour contribution, capital contribution or by taking on a financial risk (i.e. co-signing and/or personally guaranteeing a business loan).
In addition, there will be no restrictions on “income splitting” to a spouse where the professional is 65 years of age or older and has made a meaningful contribution to the business in the current or a previous tax year.
Given that “income splitting” with dividends between family members will no longer be an option in 2018 for the majority of situations, it is important for professionals to re-evaluate their remuneration strategy moving forward. What should be the appropriate mix of salary and dividends to be taken by the professional? How much should be withdrawn from the professional corporation in order to generate a sufficient after–personal tax income to meet the family’s personal living requirements?
Since income sprinkling with family members will still be permitted under certain circumstances, professionals may want to consider reorganizing their professional corporation’s share structure. This will be most beneficial if there are currently family members that were already meaningfully contributing to the business, or where the professional is 65 years of age or older. In these situations, dividends can still be split among certain family members and not trigger the adverse consequences of the new rules.
Professionals may consider buying the shares of their professional corporation owned by family members, or have the corporation repurchase these shares. With careful tax planning, it could be possible to convert what otherwise would have been taxed as a dividend to the shareholder, into a more tax favourable capital gain.
Professional corporations may also set up an Individual Pension Plan (IPP), as an additional tax planning option. The contributions made by a corporation to an IPP are tax deductible and the accumulation of income in the plan is tax-free. The professional corporation can yield the benefits of a tax deduction while the professional may be able to benefit from splitting the pension income in the future on retirement. An additional benefit of an IPP is that contribution limits are generally much higher than the limits for Registered Retirement Savings Plans, allowing for more to be invested for the future on a tax-deferred basis.
Despite the new rules restricting “income splitting”, there may be additional opportunities available for professionals to sprinkle income with family members. It is important to take stock of the current situation, determine the specific impact of the new rules and plan for the new tax landscape. Contact a Crowe Soberman tax advisor to determine whether you are impacted by the proposed rules, your options, and possible next steps in reorganizing your business structure.
This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article. Please note that this publication should not be considered a substitute for personalized tax advice related to your particular situation.
