Budget 2016 proposes tax amendments that will limit the benefits of certain corporate and partnership structures which currently allow for the small business tax rate to apply to multiple instances of $500,000 of active income. This has historically been accomplished through the use of more complex structures that use a combination of multiple corporations, partnerships and/or contracts for services. The intention is to limit the ability of high-net-worth individuals to use private corporations to inappropriately reduce or defer tax.
Below are two examples of how a physician could be impacted by this:
- Example 1: Dr. Jones is the sole shareholder of a medical professional corporation (MPC) earning $1M of active business income. Ordinarily, the MPC would be eligible to pay the small business tax rate on the first $500,000 of active business income and would pay the general corporate tax rate on the remaining $500,000. However, in order to have the full $1M taxed at the small business rate, Dr. Jones’ spouse, Mr. Jones, incorporates his own corporation and provides services to Dr. Jones’ professional corporation for a fee of $500,000. The end result is that each corporation would end up with $500,000 of active business income and each could benefit from the small business tax rate on this income. Budget 2016 proposes to eliminate this advantage in situations where one corporation, its shareholder or a person who is not at arm’s length with the shareholder, has a direct or indirect interest in the other CCPC from which it is deriving its services/property revenue.
- Example 2: Where a CCPC is a member of a partnership, the CCPC is entitled to its pro-rata share of the $500,000 small business deduction based on its share of active business income allocated to it. Therefore multiple corporate partners would have to share one instance of the $500,000 small business limit. To avoid this, structures have been implemented where an individual owns a partnership interest. The individual partners then incorporate CCPCs which, in turn, provide services or property under contract to the partnership. Each corporation would claim the small business deduction in respect of the income earned through their services contract with the partnership effectively allowing multiple partners to access the small business deduction. The new proposals would eliminate this advantage by having the corporations deemed to be direct partners of the partnership.