Dentists, who can incorporate their practice and save for retirement through the corporation, are one group affected by the tax changes.shironosov/iStockPhoto / Getty Images
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Two weeks after the release of the federal budget, there are still misunderstandings about how proposed tax changes affect incorporated business owners.
Here are four big misconceptions about how the federal budget affects corporations:
1. Capital gains are taxed the same way for individuals and corporations
As of June 25, the capital gains inclusion rate will increase to 66.67 per cent from 50 per cent for individuals, corporations and trusts, but how this will work for each group differs. The increase only affects individuals who have capital gains of more than $250,000 annually, but that’s not the case for corporations.
Instead, on the effective date, the increased capital gains inclusion rate will be applied to the first dollar of capital gains earned within a corporation, says Kevin Burkett, tax partner at Burkett & Co. Chartered Professional Accountants in Victoria. Put another way, there’s no threshold for corporations to exceed.
Even some politicians appear to be confused on this point, as Health Minister Mark Holland showed in a CTV interview last Sunday.
2. Professional corporations are the same as regular incorporated businesses
The federal budget uses the word “corporation” as an umbrella term for professional corporations and other incorporated businesses. While they’re typically treated the same for capital gains purposes, activities of a professional corporation may be restricted as their owners (such as dentists, doctors and lawyers) are governed by a professional organization.
The specific professions and the provinces grant the right for their members to incorporate their practices and earn income through the corporation, says Wilmot George, vice-president and head of tax, retirement and estate planning at CI Global Asset Management in Toronto.
“These are individuals who are governed by a regulatory body. So, as long as the regulatory body gives authority to that professional to incorporate the business, the professional can do so,” he says.
In return, professional corporations, similar to other Canadian-controlled private corporations, have access to tax strategies including the small business tax deduction. These are initiatives set up by the government to encourage entrepreneurship, Mr. George adds.
Non-incorporated businesses, such as sole proprietors, aren’t eligible for the same tax rates. Mr. George says if owners of professional corporations don’t need to withdraw all their money for living purposes and can save within their corporation, incorporation might be worth considering – although lots of number crunching is required as suitability depends on the circumstances.
Many professionals and business owners set up funds for their retirement within their corporation to take advantage of the lower tax rate. However, the increased capital gains inclusion rate will mean higher taxes when they withdraw from that pot of money.
“As a result, they will need to save longer because they need to accumulate more money to pay more taxes,” Mr. Burkett says.
3. All corporations can access the lifetime capital gains exemption
As of June 25, the lifetime capital gains exemption (LCGE) will increase to $1.25-million from around $1-million for shares of qualifying corporations, and will then be indexed to inflation starting in 2026. The LCGE is often presented as a reason why business owners shouldn’t worry about the increase to the capital gains inclusion rate. But many won’t even qualify.
To access the LCGE, at the time of sale at least 90 per cent of a business’s assets must be used in an active business at the time of sale, says Debbie Pearl-Weinberg, executive director of tax and estate planning at CIBC Private Wealth in Toronto. And for two years prior, at least 50 per cent of the assets must be used in the active business, she adds.
In reality, most professional corporations and incorporated businesses accumulate earnings in their company until they retire, Mr. Burkett says. Then, they’ll repurpose the business into a holding company, which will fund the retirement. “So, there is just no sale that would benefit from LCGE rates.”
4. Taxes affecting corporations won’t affect the average Canadian
Mr. Burkett predicts a cascading effect once companies start paying higher taxes, which will affect a much larger group of Canadians than the 40,000 the government suggested in the federal budget.
“Less profits means less dividends to pay shareholders,” he says. “Less profits could also equal lower salaries for staff or higher prices for consumers, too.”
Regardless of the circumstances, Mr. Burkett notes that most adults have “at least some indirect ownership” of shares in Canadian companies.
For example, investors may own stocks and mutual funds, exchange-traded funds, or participate in a workplace pension plan. All employed Canadians earning more than $3,500 contribute and participate in the Canada Pension Plan, which invests in shares of Canadian companies.
“Even without realizing it, most of us are invested somehow in shares of these companies and individuals derive benefit by owning shares of those companies,” he says.
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Deanne Gage