Ticking Time Bombs – Taxes0 June 20, 2017 at 8:03 am by David Chong Yen and Louise Wong
Our parents may have told you to spend within your means. If you make $250,000, don’t spend $500,000. Your accountant should, and probably did, tell you that your Professional Corporation (PC) is a separate entity from you as an individual. In other words, your PC files a separate corporate tax return and pays separate taxes from you. You file a personal tax return in addition to your PC’s tax return.
Quite often, we will observe on a dentist’s PC’s balance sheet, the caption Due from Shareholder or Loan to Shareholder. This is a ticking time bomb. We urge you to review your own PC’s balance sheet to see if this appears on yours. This likely arose because the dentist/family needed money to pay for personal expenses and took money from the PC’s bank account.
Ticking Time Bomb #1
The tax rules state that if you borrowed money from the PC, this loan must be repaid within one year after the fiscal year end in which the loan was made. For example, your PC’s year end is July 31, 2016. You borrowed money from your PC on June 30, 2016. You must repay the loan to your PC by July 31, 2017. Otherwise, if you don’t, this loan will be treated by the tax department as income to you.
The exception to this rule (applicable only for employees rather than shareholders) is where the loan was used to buy a car for business use, principal home or PC shares. The problem dentists will have is where the exception applies just to the dentist. In other words, was a similar loan from your PC extended to an arm’s length employee? If it wasn’t, then the chances of convincing the tax department that you fall into the exception category is very slim and highly risky. Even where you do repay this loan, the CRA requires you to include in your income a deemed interest benefit at the CRA’s prescribed interest rate (currently 1%) for the period the loan is outstanding.
You cannot use your PC’s bank account like your personal piggy bank. If you do, then be prepared for the tax bill, interest and consequences.
Ticking Time Bomb #2
Many dentists hire individuals on an independent contractor or subcontractor basis. Why? They save CPP, employment insurance, vacation pay (which is a minimum of 4 per cent) and possibly avoid severance and/or termination costs.
The challenge arises when the same individual is working on an extended basis for the dentist. The tax department, if they conduct an audit, could deem the individual subcontractor or independent contractor to be an employee. If this is the case, CRA will likely go back three years and levy interest and possibly penalties for the amounts which should have been paid to the government. You can only recover the employee portion of source deductions from the worker/employee for the previous 12 months i.e., added costs to you. CRA will apply these main tests to determine if the individual is a self-employed contractor.
1. Control – who has control over when, where and how the contractor works?
2. Tools and equipment – who provides the tools and equipment?
3. Chance of profit/risk of loss – who pays for the operating expenses?
4. Integration – is the worker’s job an integral part of your dental business?
Treating someone who works at your practice as an independent contractor or subcontractor has its consequences/ risks. Classifying them as an employee avoids this risk.
Ticking Time Bomb #3
Many dentists involve their families in the tax savings game by making them shareholders of their PCs. However, not all family members actually pay for the shares. If your family has not written a personal cheque to the PC to purchase the shares, then they do not own the shares. All dividends paid to the family members could be ignored and considered invalid. When it comes time to sell the PC shares, the shares being sold by family members may not exist and therefore you may not be able to multiply the lifetime capital gains exemption, which could cost you up to $220,000 per family member.
Ensure all shareholders pay for their shares to avoid future tax headaches.
David Chong Yen
David advises dentists on tax, estate and financial planning, valuations and accounting. The "hands-on" experience he has gained, from working with dentists to improve their income and to set up and manage their practices, enables him to understand their business. David steps into the dentists’ shoes when making practical recommendations.