Kickstart Your Corporation. Andrew Feindel
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Usually with professionals, tax deductions are worth more than tax credits. The exception would be if you happen to have a very low personal tax rate, with the result that you can take funds out of your corporation at a lower rate than the credit you are receiving from your donation credit. (Keep in mind, however, that we have to eventually make up every dollar we spend personally by pulling more money from the corporation.)
But beyond deductions versus credits, there are other ways to increase the tax efficiency of your donated dollars. What many Canadians don't realize is that as of May 2006, donations to registered charities of publicly listed securities are exempt from capital gains taxation on gains triggered as a result of the gift, making it more tax-efficient for donors to give securities directly to charity, rather than to sell them and give the proceeds to the charity.7
Let's look at an example of how this works: I work with a client who tithes to his local church, giving 10% of his income ($60,000 per year) to his church. To help him accomplish this goal, we set up a charitable account for him at no cost (note, many banks and financial institutions charge thousands for this setup/transaction).
When the time comes for his donation, I take the best-performing asset from the previous year and roll that over to the church. In the last transaction we did, it was an investment with a book value of $20,000 and a market value of $60,000. The church receives the same $60,000 they were to receive anyway, and they can sell the asset right away or hold on to it. The client, in turn, receives a $60,000 tax deduction, but this also saves him upwards of $10,000 in corporate taxes. Plus, the client can now withdraw $40,000 from his corporation tax-free through the capital dividend account (CDA). Since 0% of the gain is taxable, 100% of the gain is added to the CDA (see sections 83(2) and 38(a.1)(i) of the Income Tax Act).
Think about all the times you have donated, or will donate in the future, to see how much money is left on the table if you are not employing this specific strategy. You could even use those tax savings to donate to your second-favorite charity!
What Is the Lifetime Capital Gains Exemption (LCGE)?
The lifetime capital gains exemption (LCGE) is an exemption, valued at $883,384 for 2020 and indexed to inflation every year, that can be used when corporate shares are sold.
For example, if you sell your corporation for $883,384 as a share sale, not an asset sale, then you would have no taxable capital gain and pay no taxes.
Given every Canadian has access to the lifetime capital gains exemption, in many situations where the shares would sell for more than $883,384 (or whatever the limit is for that year), you would want to add family members, such as your spouse and/or children, to multiply the capital gains exemption. For instance, if you and your spouse each owned shares, for 2019 you would have, between the two of you, a total of $1,766,768 in tax exemptions ($883,384 × 2). You are not required to use the full LCGE all at once, however. Again, this can be a complex area requiring professional guidance.
(On a side note, a common misbelief is that this exemption is in some way related to the capital gains from the growth on your investments. While these are both forms of capital gain, their tax treatment is very different!)
Keep in mind the CGE only applies to the selling of shares, and not the selling of assets. This can sometimes lead to a mismatch between the seller and a prospective buyer, as sometimes the buyer would prefer to buy the assets, but—given the CGE—the seller would often be better off selling the shares. For example, you can see this mismatch when a seller is purchasing equipment that has already been depreciated on the balance sheet by the previous owner. As a buyer, you may then be in a position in which you are buying equipment for a higher value than you can depreciate, given the seller has already received the tax benefits from the years of depreciation. Depending on your side of this transaction, you may want to leverage this mismatch to influence the selling price.
Most physicians will not be able to benefit from this exemption, as it requires you to find a buyer for your medical practice. (A practice sale is much more common with dentists.) However, in recent years we have seen a rise in the sale of medical practices, given the value of patient rostering or family health organization (FHO) practices (using the FHO compensation model).
In order to qualify for the CGE, the corporation must qualify as a small business corporation at the time of sale. In order to qualify, two criteria must be met, the first being that you, or a person related to you, must have owned the shares for a 24-month holding period immediately prior to the sale. Secondly, 90% of the assets at the time of sale, and more than 50% of the fair market value of the assets held during the 24-month holding period, must have been used for carrying on an active business in Canada, or be shares and debt held in other small business corporations (or a combination of these two types of assets).
For corporations that will not pass this test, there is a “purification” method to allow the shares to qualify. In order to purify your shares and thus qualify for the CGE, you will need to set up a holding company to transfer assets to. It's very important to do this correctly. For instance, if you transfer funds as intercorporate debt, as opposed to an intercorporate dividend, your shares may be ineligible for the exemption. It should be also noted that while most assets can be transferred in kind, some assets—such as permanent insurance—may give rise to a taxable benefit if the cash surrender value (CSV) of the policy exceeds its adjusted cost base (ACB), though the ACB is usually negligible or nil in the earlier years of the policy. This is why it's best to plan this sale carefully, to avoid paying unnecessary tax.
Before we leave this topic, note that the lifetime CGE has evolved since its creation in 1986. It started with a $500,000 lifetime exemption on any type of capital gain, such as a cottage sale. In this early form, many Canadians could reap the rewards of the CGE. Then, in 1994, the CGE was reduced to $100,000 and subsequently restricted to the sale of qualified small business property, including farm and fishing property. As a result, many Canadians “crystallized” (or claimed) $100,000 of exempt capital gains.
This history is important as it demonstrates that tax policies can and do change. While many incorporated professionals will plan to use their CGE in retirement, in many scenarios it may make sense to use the lifetime CGE now, anticipating a potential rule change in the future. To use the exemption before retirement, you would trigger capital gains, resulting in an increase to the cost base of the shares. Then, when the shares are sold in the future the amount of tax paid would be dramatically reduced, due to the adjusted (increased) cost base.
Now That I Have Incorporated, Can I Deduct My Golf Membership Fees?
In a word, no!
Dues for recreational or dining clubs, such as golf or tennis clubs, are not deductible expenses, even if the expense has a business purpose, as there is a specific rule in section 18(1)(l) of the Income Tax Act that prohibits the deduction of all recreational club dues. For meals and beverages consumed at golf clubs and the like, however, the deductibility rules are the same as those that would apply at other restaurants, so long as the costs are separately itemized (they are generally 50% deductible, with some exceptions). If the full charge is shown and not itemized, the full deduction is generally disallowed.
As an aside, there was a Tax Court of Canada case involving Gillis Truckways Inc. (Gillis v. The Queen—2005 TCC 782) in which a golf membership was paid for by a corporation. In that case, the CRA reassessed a taxable benefit of 100% of the cost of the membership to Mr. Gillis, who brought the case to court; the judge directed the CRA to lower the taxable benefit down to 40% of the membership cost. Maybe with a golf lobby group the current tax rules could change!
What Do I Do with My Corporation When I Retire?
Assuming you do not sell your practice shares, when you retire your professional corporation needs to remove the “professional” title, leaving you with a numbered holding company. This is usually done with the help of a