The CRA is Looking to Attack the Issuance of Discretionary Shares to Family Members
As we have discussed in previous blog posts there are many advantages to incorporating a medicine or dentistry professional corporation in Ontario. One of the main advantages is the ability of the dentist or doctor to add their family members as shareholders in order to income split. This sprinkling of dividends has gained popularity in
Canada since the case of Melville Neuman v. Her Majesty the Queen when the Canada Revenue Agency (“CRA”) tried to attack the sprinkling of dividends. The court in Melville Neuman held that the sprinkling of dividends was allowed. While this has been a very effective method of reducing taxes for doctors and dentists the CRA is still looking to attack the sprinkling of dividends to these special shareholders. This blog post will take you through the method of income splitting, how the CRA is challenging this method and how you can avoid trouble with the CRA.
Income Splitting for Doctors and Dentists in Ontario
When incorporating the licensed dentist and/or doctor is issued the common/growth shares and the family members are issued non-voting shares which may consist of non-voting common shares or non-voting special shares. Non-voting common shares are usually issued only to the spouse and not to children. Children are most often issued classes of shares designated as non-voting special shares with each child being issued a separate class of these shares – for example child 1 would be issued Class A Special Shares, Child 2 would be issued Class B Special Shares. Most of the Special Shares have only small differences in them but the main attribute is that they are issued for very nominal consideration such as $1.00 per share and can be redeemed by the corporation for that same price of $1.00 plus declared and unpaid dividends at the sole discretion of the director of the Corporation being the professional dentist/doctor with the result that the special shares will not appreciate in value.
The special shares are issued in separate designations to each child in order to enable the professional as sole director to declare dividends on 1 class of special shares and not on another in order to sprinkle dividends to each child when that child’s tax rate is low – for example children under the age of 18 receiving dividends are subject to the “kiddie tax” which would result in them be taxed at the highest marginal rate and therefore the dentist/doctor may want to declare a dividend on shares issued to their children who are at least 18 years of age but not to children under 18.
As children age and earn their own income there may be no further tax benefit to give them a benefit and therefore the professional would stop declaring dividends on these older children but now can pay on the children previously under 18 who is now at least 18. The effect is that the professional can get money out of the professional corporation to fund their children at no or very low tax cost (other than the approximately 15.5% tax paid in the dentistry professional corporation or medicine professional corporation).
The amount of dividends that a child can receive is up to the professional but at around $40,000.00 no tax would be payable by the child (assuming no other income) and even much higher amounts may not be taxable as children may have high deductive tuition rates. If the dentist/doctor paid the money out of the medicine/dentistry professional corporation to himself or herself and paid the taxes on the $40,000.00 there would be approximately $14,000.00 of taxes – this is obvious a substantial saving for 1 child in 1 year.
CRA’s Attack on Sprinkling Dividends
As noted above, CRA is looking for means to attack the use of multiple classes of special shares and the sprinkling of dividends. As can be seen the dentistry/medicine professional corporation on day 1 issues special shares to a child for $1.00 per share and immediately thereafter declares a dividend of $40,000.00 with the substantial tax saving as noted above.
As noted above, CRA introduced the “kiddie tax” to catch dividends going to children under the age of 18. In the case of Patrice Demers v. Her Majesty the Queen decided in 2006 the court found for the CRA based in part on the following arguments:
• The shares issued to the children were never paid for by the children – i.e. the accountant apparently simply made a book entry but there was no evidence of monies actually being deposited to the corporation’s bank account from the children. There it was argued that the shares actually belonged to the parent and not the child. I would draw your attention to section 23(3) of the Business Corporations Act, Ontario, under which professional corporations are incorporated, which states “A share shall not be issued until the consideration for the share is fully paid in money or in property or past service that is not less in value than the fair equivalent of the money that the corporation would have received if the share had been issued for money. R.S.O. 1990, c. B.16, s. 23 (3).”
• The evidence was that the dividends were paid from the Corporation and deposited to the parent’s bank account. The parent was not able to give any concrete evidence that the monies were used for the benefit of the child.
CRA is also looking into the valuation of special shares at the time of issue. If, as noted above, the shares are issued for $1.00 with the expectation there will be a substantial dividend paid soon thereafter CRA may argue that the shares are actually worth substantially more than the nominal $1.00 for which they were issued in which case CRA could assess a shareholder benefit under section 56(2) of the Income Tax Act, Canada. This may not hold much water if the shares were issued on incorporation or upon a subsequent estate freeze where the parents’ shares are valued prior to the issuance of the children’s shares – in this case all of the value is taken by the parent and therefore any share issued thereafter to the children would actually have very nominal value. However, many accountants, years after incorporation, simply instruct lawyers to issue special shares to the children without 1st reorganizing the corporation through a valuation and estate freeze with the result that there no real method of determining the actual value of the special shares.
How to reduce being reassessed/attacked by CRA
• Ensure that when issuing special shares to children that the shares are actually paid for by the children. Try to take out the purchase price for the special shares from the child’s own account and ensure the consideration is deposited into the corporation’s account;
• Ensure that when paying dividends the dividends are paid to the child’s bank account and utilized for the care and maintenance of the child and not to simply pay the money to the parent. Keep good records. It may be necessary to open a new bank account with joint signing authority.
• When issuing special shares after incorporation only issue them after valuing the corporation as part of a freeze of the parent’s shares and reorganization. After the parent is given all of the value of the corporation any new special shares issued to a child would have no value and therefore it will be easier to make the argument that there was no benefit to the child.
• Ensure that any dividends declared and paid on the special shares do not reduce the value of the freeze shares that the parent received on the reorganization.
Kutner Law LLP has over 35 years of experience in dealing with the dental and medical profession. We would be happy to walk you through all of these questions and any other concerns you may have. Feel free to contact us for a free consultation to determine whether setting up a professional corporation is the right decision for you or for discussing your other legal professional queries.
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Regulations Amendments effecting the Annual Renewal Process for Dentists and Doctors
Regulation amendments to simplify the requirements for the issuance of and the annual renewal of Certificates of Authorization for health profession corporations were recently passed by the government.
These amendments change the Application and Annual Renewal Process for a Certificate of Authorization by simplifying the process as follows:
1. The requirement for a Statutory Declaration sworn in the presence of a lawyer, notary public or commissioner of oaths had been removed. A simple declaration signed by a Director (must be a dentist and member of the College) of the corporation will suffice.
2. The requirement for certified copies of the certificate of incorporation or other certificates issued under the Ontario Business Corporation Act has been removed. Ordinary printed copies will suffice.
3. The requirement for a current-dated Certificate of Status of incorporation has now been replaced with the less expensive uncertified Corporate Profile Report.
4. Names of non-voting, non-member shareholders are no longer required. In other words, the names of family members who own non-voting shares are not required.
Amendments to Ontario Regulation 39/02 (Certificates of Authorization) made under the Regulated Health Professions Act, 1991 and Ontario Regulation 665/05 (Health Profession Corporations) made under the Business Corporations Act (Ontario) were filed on December 12, 2014.
Topics: Dental, Medicine