Daily Times

In the March, 2017, federal budget, Finance Minister Bill Morneau vowed to close loopholes that were allowing the wealthy to avoid paying their fair share of taxes. Now, the government has unveiled measures that target private corporations, a category that includes the majority of Canada’s physicians. They are up in arms, and rightfully so. Incorporation is the creation of a separate legal entity with its own revenues, expenses and assets.

If a physician is incorporated, their fees (about 70 per cent of doctors are paid on a fee-for-service basis) are paid to the corporation, and the company covers overhead and expenses, including a salary paid to the physician. This is how most small businesses operate. A doctor who is not incorporated would run the practice personally, with all revenues and expenses recorded on a personal tax return, and the net amount being the salary.

About 60 per cent of Canadian doctors have opted to incorporate – principally for the tax benefits. It is also a reminder they are independent contractors, not state employees.

If a physician is incorporated in British Columbia, her small business is taxed at the rate of 12.5 per cent on the first $500,000. If she is unincorporated, the tax rate is 40 per cent on the first $140,000 in income and at least 43.7 per cent on additional income.

Incorporation is only beneficial if a physician defers income. That’s because income paid to the physician by the corporation is taxed at the personal tax rate.

The reason physicians (and other small business owners) retain money in a corporation is because they don’t have pensions or benefits like many salaried employees.

Revenue Canada is proposing three major tax reforms: changing the way it taxes private corporations on capital gains and on passive investments, and eliminating income sprinkling.

Some corporation owners have used complex steps that involve selling shares to another related company, so they can convert what would be taxed as salary or dividends into capital gains. This is not legitimate, and a reasonable change.

Similarly, an earlier measure to limit corporations selling their services to another corporation to limit the tax hit was also justified.

Ottawa also wants to limit corporations earning passive income. Money in the corporation can be invested – for example, a doctor can buy the building where the practice is located and charge rent to other tenants – and the profits are taxed at the 15-per-cent business rate. Ottawa wants to tax those earnings at the personal tax rate. This doesn’t make much sense. Those earnings will be taxed at the personal rate once they are withdrawn. All this does is prevent a corporation from building up assets.

Finally, Ottawa is proposing a crackdown on so-called “income sprinkling.” Business owners often pay salary to family members, or make them shareholders and pay dividends.

This has tax benefits; consider that two people earning $100,000 will pay about $18,000 less tax combined than one person earning $200,000. Dividends are also taxed at a lower rate than regular income – to take into account that tax has already been paid by the corporation.

These payments are subject to a test of “reasonableness.” If you pay a family member a salary, they have to work. And there are restrictions on paying dividends, especially to children.

The principal benefit of incorporation for a physician is to take advantage of the lifetime capital gains exemption, which can shelter up to $835,716 in lifetime income for each shareholder (usually spouse and children.) Ottawa wants to limit the capital gains accrued, especially when family members are minors.

This limits a physician’s ability to save for the future, which seems like a short-sighted policy measure.

This is how people with small businesses pay themselves a pension after retirement. It’s important for physicians because, unlike a store, the corporation itself does not have much value. A store owner can sell the business because it has a brand. Most physicians are hard-pressed to sell their practices when they retire; many can’t give them away.

For years, governments have urged physicians to incorporate, and even provided tips on how to maximize their tax savings with measures such as income sprinkling. They’ve touted this approach as an alternative to fee hikes. (And doctors can’t hike their fees to cover new tax hits.)

It is unfair to now claw back these benefits. It is also disingenuous – scurrilous even – to paint physicians as wealthy tax cheats exploiting “loopholes.”

Governments can, of course, change policy. But if they adopt measures that make incorporation unattractive and impossible to accumulate retirement savings, then they need to provide an alternative, such as salaries and pensions. That would mean a fundamental revamp of how physicians are remunerated. Are governments willing to open that Pandora’s box?

Published in Daily Times,August 07^th 2017.