Andrew Feindel - Kickstart Your Corporation

Let's take a look at an example.

This example assumes the following:

John is a physician earning $400,000 per year who wants to buy a condo in Toronto for $1,000,000.

We'll assume the growth rate on the condo is 4% per year, but for the moment we'll ignore all real estate transaction costs (i.e., land transfer taxes, legal and real estate commissions, and so on).

At a $400,000 income, John's average tax rate will be 44%, though his marginal rate will be 53.53%.

Let's assume John needs $100,000 of after-tax (“take-home”) pay to meet his day-to-day living expenses.

John wants to save $250,000 as a 25% down payment on the condo.

With no corporation, based on these assumptions John could save $124,000 in the first year, and it would take him a total of two years and almost three months to make up the 25% down payment on a property that may well appreciate during John's “waiting period” (meaning his $250,000 no longer represents a 25% down payment).

If John incorporates, his average corporate tax rate would be 12.2%, and he could pay out $129,000 in dividends to fund his $100,000 lifestyle spending needs (at an average tax rate of 22%), allowing him to save $223,000 in the first year.

In this scenario, he will have a $250,000 down payment within a time frame of about 15 months—cutting an entire year off the time frame for saving the required down payment.

And not only does John save up the down payment more quickly, he also saves about $40,000 on the condo purchase price, given our projection about real estate appreciation over the waiting period. How is John able to realize his down payment savings strategy so quickly and effectively? The key is his use of a shareholder loan from his corporation, which we discuss next.

The answer is a qualified yes: you can purchase your principal residence through your corporation, but you usually shouldn't .

Why not? Because you'd be giving up one of the largest benefits the tax code allows, the principal residence exemption. This benefit allows all the gains in our homes to grow tax-free, but the benefit is eliminated if the home is owned by the corporation.

Let's look at the example of a family member of mine, who purchased their home in 1987 for $750,000. Fast-forward to 2017 and this same house was sold for $4,850,000 (a gain of $4.1 million over 30 years)—as a tear-down, believe it or not! Because the house qualified as their principal residence (sheltered under section 40(2)(b) of the Income Tax Act), they didn't have to pay even a cent of tax on the $4.1 million gain—compared to a tax bill of over $1 million if the corporation had owned the house. In a nutshell, if it's your plan to hold (own) the home for many years, or unless you think the house will not appreciate in value, it's best to own your home personally.

However, there are certain situations where one may want to consider owning their principal residence through the corporation.

Let's consider a situation in which you have almost all your funds in the corporation, which would result in a very large personal tax bill to come up with that 25%-plus down payment. Let's also assume we are purchasing a property to own for less than five years, so the likelihood of significant capital appreciation is relatively low.

In this case, the benefit of purchasing the property through the corporation would be to come up with the payments through lightly taxed corporate dollars, as opposed to much more heavily taxed personal dollars. However, given that the house is still a personal-use property (a tax concept that refers to items you own primarily for the personal use or enjoyment of your family and yourself), you would need to either pay rent to the corporation for the equivalent market rent—which results in having to pull out money from the corporation—or take a taxable benefit for the market rent.

The former (paying rent) allows further deductions in the corporation for many of the costs—such as interest, utilities, and hydro—but would likely result in a higher personal tax bill. That's because you would likely need to withdraw double the amount needed for rent in order to pay the tax due on the withdrawn income. This option could also create problems under the new passive income rules (which came into effect for taxation years beginning after 2018), as rental income (paid to your corporation) counts toward the $50,000 threshold.

All in all, the only situations in which we've seen it make sense to have the corporation own your principal residence is when you take a taxable benefit for the imputed rent. (This is a complicated area of tax law, where professional advice is most definitely warranted!)

In making your decision about whether to own your principal residence personally or through your corporation, you will need to estimate and weigh all these costs—loss of the principal residence exemption, potentially higher loan costs when borrowing corporately as opposed to personally—against the potential benefits, which are the savings of after-(corporate)-tax dollars versus after-(personal)-tax dollars.

As a shareholder, you can take a loan from your corporation. Here's how that works: you can personally borrow money from the corporation and will not have to repay the loan until one year after year-end, giving you a repayment window of up to 729 days. Shareholder loans can be helpful in situations like the one we've just discussed, when you need to take on debt for personal reasons—whether that's financing your personal residence, cottage, or vehicle.

On your corporate books, the loan will appear as an asset to your company and a liability to you. In repaying the loan, you will need to pay the daily prescribed interest rate (currently 2%) or have a deemed interest benefit, but this will be less than the current prime rate (currently 2.45%). 6 All things considered, I would much rather see you pay the prescribed interest rate to your corporation than a higher interest rate to the bank for your debt payments.

One more note about shareholder loans: it is very important to make sure you repay any loan you receive from the corporation. If you fail to repay the loan, you will have to add the borrowed amount to your personal income tax return, and you will be charged interest by the Canada Revenue Agency (CRA) for taxes owed. Also, once you have repaid the loan, you should avoid additional shareholder loans, as the CRA could potentially penalize you for a series of loans.

A professional corporation differs from a “normal” corporation in that it offers no creditor protection to its directors and shareholders, and no protection from personal liability in the case of professional negligence.

While there are certain ways to ensure creditor protection for your assets, I believe the issue of creditor protection may not be as relevant in the medical industry, given that most professionals have coverage through their association. (Professionals should check with their provincial or territorial regulatory body for details on their particular circumstances.) The professional corporation can provide limited personal liability covering non-professional liabilities (such as office space lease liabilities and bank loans that are not personally guaranteed).

With that said, you can look at forming a separate holding corporation or investing in creditor-protected assets, such as segregated funds, to help provide extra measures of credit protection. Both options, however, will result in extra accounting, legal, or management fees—which is why a cost–benefit analysis should be completed with your financial advisor before you take any action.