When I started this Blog of Ice and FIRE, I likened the medical climate in Canada to the seasons of the fantasy world in Game of Thrones. There are long bountiful Summers that can last years, followed by long dark Winters when armies of the undead march down to pillage the Southern Kingdoms.
The Winter usually starts with sightings of the creepy White Walkers and their zombies. This is followed later by the appearance of their necromancer leader, The Night-King.
We have been heading into one of those Winters.
Our governments have spent beyond their means. They need to cut costs where they can, but that is politically unpalatable. Generating more tax revenue can also be a mine-field. However, professionals are easy targets.
We are prominent high-incomers, relatively small in number, and we won’t stop fulfilling our duties – even when under attack. So, there are potential savings and revenue with limited repercussions to voters and therefore politicians.
We had some harbingers of Winter with White Walker Wynne in Ontario unilaterally imposing a 4.5% across the board clawback of physician fees. Ontario doctors have been without a negotiated contract for years now.
Those clawbacks come off of our monthly payments like an income tax installment. Wynne also created higher income tax rates on those earning six figure salaries. This has been seen in many provinces.
In 2016, the Federal government made yet another new higher marginal tax rate.
Thus pushed the top combined rate to over 50% east of Saskatchewan and up to 54% in many places. Added onto the 5% fee clawback (a de facto “Ontario Doctor Tax”), that is now almost a 60% top marginal tax rate on medical practice in Ontario. Punishing.
This would certainly motivate physicians to leave money in their professional corporations rather than pay it out and have over half of it confiscated.
Alas, our hard earned money was still not safe within our professional corps.
This past summer, the Night-King Mourneau was sighted and announced further plans to attack Canadian Controlled Private Companies (CCPCs) and a broad swath of small businesses. Unwittingly, he drew in difficult political targets like farmers, fishers, and the Mom and Pop small businesses that are the backbone of our economy into his attack.
People across Canada’s small business community banded together to fight back. A seemingly unstoppable breech of The Wall by the armies of the Night-King and White Walkers met resistance.
When all seemed lost, there were some strong blows struck back against the shuffling army intent on consuming the life force from Canadian small businesses.
We have awaited the outcome of the battle for a several months.
Now, the Night-King has arrived South of the Wall and today delivered his 2018 Federal Budget.
The full budget document can be found here. I will hit the highlights below.
Income Splitting Via Dividends From Professional Corporations
Measures to limit income splitting using CCPCs were announced in December. I outlined the proposed rules in Let’s Keep the Sprinkler Running. I have also done a big series of posts on other ways to income split in the Financial Planning section and with demonstrations in the Sim Lab area of the site.
Passive Investments In Professional Corporations and CCPCs
There will not be grandfathering of old investments with new investments facing new punitive tax rules as originally planned. That plan ran afoul of tax integration. One of the main pillars of our tax system that aims to make income the same weather earned directly or through a company. No special penalty allowed.
The changes will take effect for 2019 and onwards.
Instead, they are taking an approach of decreasing the amount of business income that the lower small business tax rate applies to as the amount of passive investment income increases. Starting at $50K of passive investment income in a year, the threshold for the Federal small business rate will decrease by $5 for every $1 of passive income and disappear by $150K/yr of passive income.
Essentially, CCPCs that earn larger passive investment incomes will start paying the higher corporate tax rate at lower active income thresholds.
Capital gains from active investments will be excluded. Passive investment capital gains would count. However, it is only the taxable half of the capital gain that counts with the 50% excluded half not counting. With that, using capital gains oriented passive investments that don’t pay interest or dividends could effectively double the passive investment income that you could receive.
So, not nearly as bad as it could have been.
I provide a detailed explanation of what counts as passive investment income here.
Paying out dividends and Refundable Dividend Tax On Hand (RDTOH)
The RDTOH account is a notional account which means it only exists on paper for accounting purposes. The idea is that passive income in a CCPC is taxed upfront at a higher rate than an individual would pay. That is to discourage using a corporation just to invest. About 60% of that tax collected is held as RDTOH.
When the money is passed on to the individual, the RDTOH is refunded to the corporation. The dividend is taxed in personal hands. That way the amount of tax paid on the investment income overall would be similar whether paid to the individual directly or through a CCPC.
Currently, it is possible if you have a corporation making over $500K to pay the General Corp Tax rate on some earned income. You could then give a lower taxed eligible dividend from that portion of income. At the same time, it was possible to have that eligible dividend dispersal to trigger the ability to a give tax-free dividend from the Refundable Dividend Tax On Hand (RDTOH) account of the CCPC resulting in an overall lower tax-rate.
They will close that gap and make two notional accounts in a corporation.
There will now be an eligible RDTOH and a non-eligible RDTOH account. You will only get that nRDTOH from the investment income taxed at the higher small business passive investment income rate if paying out the higher taxed non-eligible dividends from the CCPC.
I know, it all sounds like Klingon speak to me. I translate the Klingon-sounding RDTOH changes into plain English (with diagrams) here.
Good News – this is much better for most than the original proposal
There are many ways that a practicing physician or other high-income professional could avoid pushing themselves into the higher general corporate tax rate. In general, it does mean the end of simply having a CCPC and paying yourself with dividends whilst building up a large investment portfolio within the corp. However, it will likely mean that we need to utilize salaries, RRSPs, and possibly taxable accounts to make a more complex financial plan for our retirement saving and wealth building.
Love the Game of Thrones analogy! And the pics….awesome! Physicians are like the Freefolk getting pushed around! 🙂
Looking forward to your posts.
Totally. We are going to get our dragons on the case. Shotgun on riding with Daenerys.
excellent and quick post, LD!
The $50K is not indexed and not accumulative. If there is a dividend payout, I think the tax credit is taken away. I guess the good thing there is a year to plan.
Not sure if there are many good options left. IPP/Insurance/RCA, but none are as good as before. In fact, it was too good and too publicized.
Look forward to your posts.
Thanks! I think that the penalty with dividend payouts is that if you cross into the red part of my chart and pay out a dividend that you lose the Refundable Dividend Tax On Hand. I’ll update the post once I clarify that piece.
Nothing will be as simple/good as the previous system and I think that the corp as a standalone strategy is dead. I can already see a number of possibilities on how to adapt in different scenarios. It will likely be more complex and I am planning on collaborating with a number of smart experts over the next month to problem solve.
I updated the post to include the RDTOH and General Corp Tax rate change. Thanks for bringing it up. I was also able to confirm that it is only the taxable portion of capital gains that counts as passive income. So, if you used capital gains oriented investments that don’t pay dividends (or change dividends into capital gains like swap-based ETFs), then you could conceivably double the effective passive income that you could generate from your CCPC.
Swap-based ETF is an option, but there is always the risk this government could change the rules and force you to liquidate. Do you know if the passive income is net or gross? for example, is it the income after deduction of discretionary investment management fees? I assume it would be, but not sure.
Not sure if I understand this correctly, does this mean a HoCo would shield passive income from opCo? (from my accountant) [A useful exclusion from the “investment income” definition is for dividends received from connected corporations, which, thankfully, means that holding companies can still be put to their useful purpose of storing the money, in a place where it is hoped to be more or less safe from general business liability concerns.]
Hope you will post strategies for people who accumulated significant amount in their corp 🙂
Excellent point about swap-based ETFs. There are some other risks with them also and you need to consider some special fees they have too. I have nibbled at them and am planning a post on them sooner rather than later. Nothing is safe from the government, as we have seen, but I am leary of living in fear of them. For example, the spectre of them increasing the inclusion rate on capital gains back up to 75% has loomed in the last few budgets. I did respond to that concern last year and realize some capital gains just in case. It worked out ok because I had some losses to play them against. However, if not then I would have been paying tax then and losing out on the tax deferred growth since my fear was never realized. I did hear rumblings about them going after swap-based ETFs, but they backed off. They are a very very small player in the finance industry in Canada so far (may change with this threshold legislation). I still worry about the capital gains inclusion though – especially now since people may use cap gains to effectively keep under the current proposed thresholds. It would also fit the refrain of “only rich people can afford to invest, so we should tax investors to increase governmental supports for the larger voter base”.
Regarding related corps, this is from the budget “Under the proposal, if a corporation and its associated corporations earn more than $50,000 of passive investment income in a given year, the amount of income eligible for the small business tax rate would be gradually reduced”. I am not an accountant, but that line concerns me about that strategy. I am going to be working with some planning and tax experts over the next month to look at strategies. My next meeting is later today, but it will likely take a month or so to digest it all and put out something accurate and well thought out. Plus, I am going to go on an RV vacation with my family for a few weeks and if I blog too much, they will strap me to the front grill.
I am most concerned about those who built up large sums in their corps. The lack of grandfathering was a dirty move. That said, I already have a few preliminary ideas. Will be posting them for sure once I flesh them out and run them by some people in the know.
If the passive income is all earned as eligible dividends received from publicly traded companies, will the $50k limit apply to the actual amount received or to the grossed-up taxable amount of the dividend?
Thanks for your posts on this. I look forward to reading more.
Thanks for the great question and for stopping by! For investment income in a CCPC, eligible dividends are simply treated as investment income with no gross-up. The grossed up process is only part of the dividend tax credit part of personal income tax. That means in the CCPC, it pays a higher combined tax rate up front (~50% for small businesses) and the difference between that and the individual rate (~38%) is put into the notional RDTOH account that can then be refunded when the money from the dividend is paid out of the corp. That RDTOH could only be refunded if you are paying yourself non-eligible dividends under the new rules (you need to stay out of the red zone in my chart above). I touched on it above briefly, but it is a bit convoluted and likely deserves a full post at some point…
You are correct LoonieDoc – Spoke with my accountant today, and he confirmed that the passive income from Holdcos will be included in the calculation of passive income from MPC. 🙁
Thanks for looking into all this for us and explaining it! Enjoy your “luxury” RV trip!
No problem. Had a great meeting today with a wealth manager that I am collaborating with. He has a similar passion for educating and problem solving which is how we connected. A number of nuances and options to look at, but I think there are good options. More to come!
Enjoy your vacation and yes don’t blog too much! I spoke with my MD advisor who didn’t know as much as you. I can only imagine the time it takes to gather the information and post.
Just don’t forget to setup a prescribed loan before March 31if that’s a potential strategy.
I wanted to check before answering your question about fees. It should be passive investment income net of deductible fees, but no one has seen that in writing.