Sep 25th, 2020
Apr 4th, 2016
By Morris Jacobson
In Quebec, small businesses benefit from a reduction of their tax payable on the first $500,000 of active business income. The small business deduction (“SBD”) applied on this $500,000 has reduced the federal corporate tax rate to 11% instead of 15%, and the Quebec tax rate to 8% instead of 11.9%, resulting in total tax deferrals of up to $39,500 annually. Since January 1, 2016, the preferential federal rate was reduced to 10.5% while the Quebec rate has remained the same. While this 0.5% reduction is somewhat good news, the recent federal and provincial budgets introduced several measures to limit access to the SBD which could have a direct impact on incorporated professionals.
2016 Quebec Budget
Applicable to taxation years starting after December 31, 2016, the Quebec SBD will be available only to a Canadian-controlled private corporation (“CCPC”) if during the taxation year, its employees worked at least 5,500 hours (maximum of 40 hours per week per worker, which hours must be paid, except for the shareholders). This measure replaces the criteria applicable in 2016 which requires CCPCs to have at least three full time employees in order to benefit from the preferential rate. Overall, such measures will increase the tax liability of the majority of incorporated professionals by 3.9% on their first $500,000 of income because they most likely would not be meeting such new requirements.
2016 Federal Budget
In the 2016 federal budget published last week, the Liberals introduced new measures to restrict the multiplication of the SBD. Before this announcement, the existing rules in the Income Tax Act (the “Act”) regarding specified partnership income already restricted the multiplication of the SBD when a business was carried on by a partnership composed of corporations not associated with each other. This resulted in only one SBD to be shared among the corporate partners. However, the CRA issued many private rulings confirming that these rules did not apply when the controlling individual and not the professional corporation itself is the member of the partnership and the professional corporation earns fees from the partnership under a contract of service. In those cases, each corporation could benefit from its own SBD. This type of structure, which has been used by many doctors, is now targeted by the new measures, such that the multiplication of the SBD is no longer possible for taxation years starting after December 31, 2016. These measures essentially deem the professional corporation to be a member of the partnership and not the individual, so that the SBD must be shared amongst all the partners.
Such measures are also applicable when the business is carried on by a corporation instead of a partnership and the individuals physically rendering the services are shareholders of both this corporation and their own professional corporation which is under a contract of service in exchange for a fee with the corporation.
Take, for example, the case of a partnership created between five doctors, where each doctor incorporated his practice and realizes an annual income of $250,000 through his or her professional corporation. Before 2016 and provided that the appropriate structure was in place, all five corporations would be taxed at a rate of 18.5% instead of 26.9%. With the new measures, they would have to share the SBD, thus resulting in each corporation being taxed at a rate of 22.3% on the first $100,000 of income (namely 11.8% provincially, assuming the new requirements are not met, and 10.5% federally) and at 26.8% on the rest. Overall, this would mean that $750,000 of income earned by the five doctors would now be taxed at a higher corporate rate.
Quebec has not introduced similar measures in its budget but it is likely that similar rules will be enacted.
Notwithstanding the significant restrictions on the SBD, incorporated professionals can still benefit from various tax advantages, namely the possibility of income splitting with family members (except for minor children) and the deferral of a significant portion of taxes by maintaining a part of the profits inside the corporation. It is also to be noted that such new measures would not apply when an entity is created by professionals with the sole purpose of sharing expenses, but not revenues.
In light of these new measures applicable in certain cases, we would recommend that professionals such as doctors seek legal advice in order to consider their options. We would be happy to assist to that effect; please communicate with Me Morris Jacobson ((514) 875-8683) or Me Nathalie Proulx ((514) 875-3562) should you wish to discuss your situation.