Tag: Professionals

Deductibility of professional’s run-off insurance post-practice

At issue

In order for someone to claim a tax deduction, our tax system requires that there be an income source to which an expense relates, and that the purpose of the expense is to produce such income.

For a professional who ceases practice, it would thus seem unlikely that deductibility would be available for an amount expended after the business has ceased to exist.  However, where that expense relates back to the pre-retirement period when professional services were being rendered, deductibility comes back into the picture.

Income Tax Act (ITA) Canada 

ITA subsection 9(2) makes reference to calculation of a taxpayer’s loss from a “business or property” for a taxation year.  It requires that a taxpayer’s loss, if any, from that source be determined by applying the ITA provisions for income computation.  Put another way, if there is no business or property income for that taxation year, in principle there can be no deduction.

Furthermore, an expense must fulfill the purpose requirement under ITA paragraph 18(1)(a) dealing with business or property, whereby:

18. (1) “… no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property”

A.G. (Canada) v. Poulin, 1996 DTC 6477 (FCA)

Poulin was a real estate broker who had ceased carrying on business in 1984.  In 1987, he was found liable to a past client in relation to a transaction from 1976.  Poulin sought to deduct the $385,802 adjudged award as a business loss in 1987, and to carry the remaining loss to other years.

The court held that the fact that Poulin was not carrying on the business in 1987 did not preclude him from seeking to claim under paragraph 18(1)(a), “as long as he was engaged in completing the things he had done in carrying on his profession, even though at that point he was no longer carrying on business and could no longer act on behalf of clients.”  The claim would have to relate to an impugned act that was necessary in order to carry on a trade or profession, but may have been performed improperly.  

Unfortunately for Mr. Poulin, the court went on to determine that the damages in the circumstances related to a tort – an unlawful or deliberate act committed with the aim of causing damages – which it found was foreign to his profession, thereby ruling out deductibility.

2015-0618981E5 – Deductibility of run-off insurance premiums

The question was posed to the Canada Revenue Agency (CRA) whether a retired professional can deduct run-off insurance premiums from business income in the year the premiums are paid, even if the professional has ceased to carry on business in that year.

Citing Poulin as authority, the author of this CRA letter opines that, despite that the taxpayer may no longer be in practice, run-off insurance premiums may be deductible in the year paid.  The claim must conform with ITA deductibility requirements generally, and relate to work performed “during the ordinary course of the professional’s business operation.” in the pre-retirement timeframe.  Presumably the reference to “ordinary course” distinguishes offside activities such as in Poulin. 

Practice points

  1. Tax deductibility requires that an expense relates to producing business or property income, most often with both expense and income arising in the same year.
  2. Bearing in mind that CRA letters are not legally binding, it would appear that CRA’s administrative position is that run-off insurance premiums may be deductible when paid in a post-retirement year.
  3. Irrespective of tax deductibility, a retiring professional would be well-advised to consider run-off insurance coverage if it is available, in order to provide a degree of protection from a post-practice claim.

Professional corporations: Who, how and why?

Business owners have a few options when choosing the legal structure for providing goods and services – most commonly sole proprietorships, partnerships and corporations.

Of those, a corporation is clearly distinguished as a separate legal entity from those who own and operate it. This opens the door to potential tax advantages, enhanced creditor protection, extended business continuity and sharing of ownership. However, not every business is entitled to unbridled use of a corporation, particularly in the case of professional services.

The availability and constraints placed on “professional corporations” varies from one profession to another and across provinces. Navigating the rules can be challenging, but doing so will allow a professional to make an optimal decision on how to best structure a practice. This article outlines the key issues that are explored in greater depth in our Tax & Estate InfoPage titled Professional corporations.

Corporations, liability and malpractice

To repeat, a corporation is a separate legal entity from its owner/shareholders. To the extent that shareholders have not given guarantees, their personal exposure is generally capped at – or “limited” – to losing their initial investment.

This characteristic is also true of professional corporations in general business dealings, but there is no shield against malpractice claims. The professional remains personally responsible for the professional services and advice given, for which appropriate liability insurance is invariably required as a condition of the licence to practice.

Tax aspects of incorporation

Our tax system is set up so that roughly the same amount of tax is paid whether income is earned personally or through a corporation then paid as a dividend to a shareholder. The accompanying table illustrates how this integration of corporate and personal taxation works.*

Professional income earned personally

  • Income                                          $1,000
  • Personal tax (45%)                  ($450)
  • After-tax cash                             $550

Professional income earned by corporation

  • Income (A)                                  $1,000
  • Corporate tax (15.3%) (B)      ($153)
  • Net income                                   $847
  • Dividend to shareholder         $847
  • Gross-up (18% rate)                 $153
  • Taxable dividend                    $1,000
  • Personal tax (45%)                ($450)
  • Dividend tax credit                   $153
  • Net personal tax (C)              ($297)
  • After-tax cash (A – B – C    $550

* Model tax rates are used for illustration purposes and rounded for ease of display.  Actual rates will vary by province, but there is no material difference in the comparative after-tax cash, being on average less than a quarter of a percentage point across the provinces.

Still, the use of a corporation may enable both tax savings and tax deferral.

Simply put, tax savings arise where the rate of tax is lower than would otherwise apply. Personal tax rates for an unincorporated professional may be 50% or more depending on province, whereas the corporate small business tax rate ranges from 11% to 19%. Comparatively, a corporation will usually have significantly more to reinvest in building the business than will an unincorporated professional.

Tax deferral is the ability to push taxation to a later point in time. If the professional does not need all the earnings of the business for current personal needs, the excess could be left in the corporation, thereby deferring tax otherwise applying to a dividend. That excess may be invested by the corporation (though some professions are limited in this respect), with the earnings and originally invested principal paid out as dividends when desired in future.

As you may expect, the actual tax operation of a corporation is more complex than this high-level outline. Our Tax & Estate InfoPage titled Illustrated corporate-personal tax integration explains these concepts step by step, and our Tax & Estate InfoCard titled Personal and corporate tax integration –  2015 summarizes the current effective rates by province and income type.

Qualifying professionals and shareholders

To one degree or another, incorporation is available to the traditional professions: accountants, doctors, dentists, engineers and lawyers. As well, those who provide services subject to provincial licencing are often able to incorporate, for example in health care support and a variety of financial services. Normally this is achieved through a combination of a provincial regulation and a bylaw passed by the particular profession’s governing body.

Beyond the professional personally, other individuals may also be allowed as shareholders, though without voting control. At the least, that usually means a spouse and children, but it may extend to parents, siblings, other blood relatives and possibly beyond. Those other shareholders will be able to receive dividends and may be entitled to some amount of the proceeds of the future sale of the practice.

Our Tax & Estate InfoPage titled Professional corporation – Shareholder rules 2015 provides details on who can incorporate, who can be shareholders and what restrictions may apply to operation and ownership.