Using a Newly formed Dentisty Professional Corporation to Enjoy the $800,000 Enhanced Capital Gains Exemption on the Sale of Shares of Your Dentistry Professional Corporation

USING A NEWLY FORMED DENTISTRY PROFESSIONAL CORPORATION (formed shortly before the sale) TO ENJOY THE $800,000.00 (indexed by a factor of 1.017 being $813,600.00 for 2015) ENHANCED CAPITAL GAINS EXEMPTION ON THE SALE OF SHARES OF YOUR DENTISTRY PROFESSIONAL CORPORATION

A number of unincorporated dentists practicing in their personal names as sole practitioners (not in their Dentistry Professional Corporation (“DPC”)) have recently asked whether they have to wait two (2) years to qualify before enjoying the enhanced capital gains exemption. Although we posted a blog on the capital gains exemption some time ago we felt it was timely to update the blog.

Facts

1. Dentist has been practicing in his own personal name and not through his DPC.
2. Dentist wants to sell his practice and asks us if he is able to incorporate his Practice and sell or does he have to wait a further two (2) years before selling his shares to qualify for the $800,000.00 enhanced capital gains exemption.


Qualifying for the Enhanced Capital Gains Exemption

Dentist practices in an Existing DPC

From a tax perspective, there may be no better advantage (other than the low tax rate in the DPC of approximately 15%) of incorporating than the Capital Gains Exemption (the “Exemption”) for Qualifying Small Business Shares of a DPC.

As of 2015, up to $813,600.00 of your capital gains realized on the sale of your shares of your DPC can be exempted (per individual over the course of their life). The Exemption can be used by any shareholder (including your spouse and children (if properly set up) of your DPC – see below under the heading “Selling with a Newly Incorporated DPC” where spouse and children would most likely not enjoy the exemption.

When selling the shares of your DPC a capital gain occurs when you sell shares and the value of those shares has increased over the cost to you of the shares. As it stands now 50% of capital gains are taxable and 50% are not subject to tax. Therefore, if you have a capital gain of $813,600.00 and do not qualify for the Exemption $406,800.00 of your gain will be tax free and the remaining 50% will be taxed at your marginal tax rate of approximately 46% (assuming the highest marginal tax rate) = $187,128.00 tax. If your spouse or other family member is/are also a shareholder they may also qualify. If you qualify for the Exemption your saving, as noted, will therefore be the $187,128.00 tax paid in the example above.

For the Exemption to apply the following rules should be reviewed:

•    At the time of the sale you have been practicing either personally or through your DPC for at least 24 months;

•    At the time of the sale, a minimum of 90% of the DPC’s assets must be used in an active dentistry practice/ business. For example if you have passive assets such as cash, stocks, bonds or real estate not used in the active practice/business at closing your DPC will not qualify. The corporation can be cleansed, prior to the closing, of your passive assets by a reorganization to ensure that your DPC does qualify for the 90% rule. This should be done prior to you contemplating the sale of shares (although there are exceptions where the DPC can be cleansed up to closing);
•    In the preceding 24 months prior to the sale more than 50% of the DPC’s assets must have been used in the active dentistry practice. Again, if you are contemplating a sale of your practice ensure that you have your lawyer and accountant review the DPC on a regular basis in order that it qualifies – if your DPC has more than 50% of its assets in passive assets during the last 24 months prior to the sale this cannot be corrected and you would have to wait 24 months from the time the passive assets were cleansed from your DPC to bring the percentage of passive assets below 50% value of the total value of the assets of your DPC (being the value of your active Practice and passive assets). If you pass away your estate could also qualify for the capital gains exemption as long as the 50% rule is met. Many dentists postpone having their DPCs cleansed of its passive assets as they advise us they have no intention of selling – if the dentist dies the estate would be burdened by the additional payment of  tax as noted in the above example. Also if the dentist became disabled he/she would have to wait the 24 months if the DPC did  not qualify.

•    To qualify the selling dentist must also not have a CNIL problem (Cumulative Net Investment Loss). CNIL is created where you have had tax shelter losses, your investment expenses exceed your investment income (eg. Losses from real estate), interest on money borrowed for investments, etc..

Dentist practices personally and incorporated DPC immediately prior to sale

As noted above we have been asked many times by dentists practicing personally whether they can incorporate a new DPC in order to sell their shares and enjoy the Exemption. The answer is generally yes if the following rules apply:

•    Section 110.6(14)(f)(ii))(A) of the Income Tax Act, Canada applies when an active business (in this case a dental practice) is rolled into a corporation (in this case rolling the active Practice into a DPC);

•    You have to have been actively practicing for at least 24 months  prior to the sale as an individual (or as an individual and in your DPC after rolling your practice to the DPC);

•    You should not roll your Practice into the newly formed DPC immediately prior to the sale. For example I would suggest not transferring to the DPC on a Sunday and closing the sale of the shares on the Monday.  You do not want Canada Revenue Agency to question whether a business (the Practice) has been carried on in the DPC prior to the sale. We suggest giving yourself at least a few days of operation of the active Practice in the DPC prior to the sale.

•    Issue the rollover shares to the shareholder before issuing the shares to the dentist as the subscriber shares may not qualify for the exemption as only the value of the proceeds that are allocable to the shares for the transfer of the proprietorship to the DPC would be eligible for the Exemption. Ensure that substantially all assets of the individual’s practice needed to operate the Practice is rolled into the DPC to ensure the provisions of the Income Tax Act in 54.2 and 110.6(14)(f)(ii)(A) as all or substantially all the assets of the Practice are in the DPC and used in the DPC.

•    You would   incorporate and roll your practice into your newly incorporated DPC on a tax free rollover prior to the closing (Section 85 of the Income Tax Act).

•    Can your spouse or family members also enjoy the capital gains exemption?  Most likely not where the Practice has been rolled into the DPC almost immediately prior to the Closing.

 


Kutner Law LLP, has been assisting dentists for over 35 years and would be happy to set up a free consultation to discuss your sale or simply whether your DPC presently qualifies and, if not  to assist you to reorganize your DPC to ensure it does qualify for you to enjoy the Capital Gains Exemption. This blog post does not constitute legal advice and should not be relied on. Please discuss the foregoing with your accountant and lawyer before you plan to sell.


 

Qualifying for the Enhanced Capital Gains Exemption

Dentist practices in an Existing DPC

From a tax perspective, there may be no better advantage (other than the low tax rate in the DPC of approximately 15%) of incorporating than the Capital Gains Exemption (the “Exemption”) for Qualifying Small Business Shares of a DPC.

As of 2015, up to $813,600.00 of your capital gains realized on the sale of your shares of your DPC can be exempted (per individual over the course of their life). The Exemption can be used by any shareholder (including your spouse and children (if properly set up) of your DPC – see below under the heading “Selling with a Newly Incorporated DPC” where spouse and children would most likely not enjoy the exemption.

When selling the shares of your DPC a capital gain occurs when you sell shares and the value of those shares has increased over the cost to you of the shares. As it stands now 50% of capital gains are taxable and 50% are not subject to tax. Therefore, if you have a capital gain of $813,600.00 and do not qualify for the Exemption $406,800.00 of your gain will be tax free and the remaining 50% will be taxed at your marginal tax rate of approximately 46% (assuming the highest marginal tax rate) = $187,128.00 tax. If your spouse or other family member is/are also a shareholder they may also qualify. If you qualify for the Exemption your saving, as noted, will therefore be the $187,128.00 tax paid in the example above.

For the Exemption to apply the following rules should be reviewed:

•    At the time of the sale you have been practicing either personally or through your DPC for at least 24 months;
•    At the time of the sale, a minimum of 90% of the DPC’s assets must be used in an active dentistry practice/ business. For example if you have passive assets such as cash, stocks, bonds or real estate not used in the active practice/business at closing your DPC will not qualify. The corporation can be cleansed, prior to the closing, of your passive assets by a reorganization to ensure that your DPC does qualify for the 90% rule. This should be done prior to you contemplating the sale of shares (although there are exceptions where the DPC can be cleansed up to closing);
•    In the preceding 24 months prior to the sale more than 50% of the DPC’s assets must have been used in the active dentistry practice. Again, if you are contemplating a sale of your practice ensure that you have your lawyer and accountant review the DPC on a regular basis in order that it qualifies – if your DPC has more than 50% of its assets in passive assets during the last 24 months prior to the sale this cannot be corrected and you would have to wait 24 months from the time the passive assets were cleansed from your DPC to bring the percentage of passive assets below 50% value of the total value of the assets of your DPC (being the value of your active Practice and passive assets). If you pass away your estate could also qualify for the capital gains exemption as long as the 50% rule is met. Many dentists postpone having their DPCs cleansed of its passive assets as they advise us they have no intention of selling – if the dentist dies the estate would be burdened by the additional payment of  tax as noted in the above example. Also if the dentist became disabled he/she would have to wait the 24 months if the DPC did  not qualify.
•    To qualify the selling dentist must also not have a CNIL problem (Cumulative Net Investment Loss). CNIL is created where you have had tax shelter losses, your investment expenses exceed your investment income (eg. Losses from real estate), interest on money borrowed for investments, etc..

Dentist practices personally and incorporated DPC immediately prior to sale

As noted above we have been asked many times by dentists practicing personally whether they can incorporate a new DPC in order to sell their shares and enjoy the Exemption. The answer is generally yes if the following rules apply:

•    Section 110.6(14)(f)(ii))(A) of the Income Tax Act, Canada applies when an active business (in this case a dental practice) is rolled into a corporation (in this case rolling the active Practice into a DPC);
•    You have to have been actively practicing for at least 24 months  prior to the sale as an individual (or as an individual and in your DPC after rolling your practice to the DPC);
•    You should not roll your Practice into the newly formed DPC immediately prior to the sale. For example I would suggest not transferring to the DPC on a Sunday and closing the sale of the shares on the Monday.  You do not want Canada Revenue Agency to question whether a business (the Practice) has been carried on in the DPC prior to the sale. We suggest giving yourself at least a few days of operation of the active Practice in the DPC prior to the sale.
•    Issue the rollover shares to the shareholder before issuing the shares to the dentist as the subscriber shares may not qualify for the exemption as only the value of the proceeds that are allocable to the shares for the transfer of the proprietorship to the DPC would be eligible for the Exemption. Ensure that substantially all assets of the individual’s practice needed to operate the Practice is rolled into the DPC to ensure the provisions of the Income Tax Act in 54.2 and 110.6(14)(f)(ii)(A) as all or substantially all the assets of the Practice are in the DPC and used in the DPC.
•    You would   incorporate and roll your practice into your newly incorporated DPC on a tax free rollover prior to the closing (Section 85 of the Income Tax Act).
•    Can your spouse or family members also enjoy the capital gains exemption?  Most likely not where the Practice has been rolled into the DPC almost immediately prior to the Closing.
Kutner Law LLP, has been assisting dentists for over 35 years and would be happy to set up a free consultation to discuss your sale or simply whether your DPC presently qualifies and, if not  to assist you to reorganize your DPC to ensure it does qualify for you to enjoy the Capital Gains Exemption. This blog post does not constitute legal advice and should not be relied on. Please discuss the foregoing with your accountant and lawyer before you plan to sell.