Law Times

LaW TIMeS • NOVeMBeR 30, 2015 Page 9 www.lawtimesnews.com Lower taxes and funded pensions Law firms miss advantage of professional corporations BY JULIUS MELNITZER For Law Times ince 2001, incorporation for law firms has been a possibility. Despite its ad- vantages, only a relatively small proportion of law firms that could benefit from incorpo- ration have in fact done so. "It's hardly new," says David Rotf leisch of Rotf leisch & Samu- lovitch Professional Corporation in Toronto. "Lawyers have always been notorious for their lack of tax planning." There are both tax and non- tax reasons for lawyers to con- sider incorporation, Rotf leisch points out. The main benefit is creating a tax deferral by retaining earnings in the professional corporation. A PC can also take advantage of the $800,000 capital gains ex- emption available for the sale of a small business, which can only be claimed on the sale of shares of a qualifying corporation and not for the sale of a sole legal pro- prietorship or a legal partnership. It also allows for the creation of individual pension plans funded by corporate assets. On the other hand, PCs are subject to strict rules governing the taxation of shareholder ben- efits such as shareholder loans or the use of company cars. A PC incorporated in Canada by lawyers who are Canadian residents will most likely qualify as a "Canadian-controlled pri- vate corporation." Such entities can claim the small business de- duction. "The small business deduc- tion features a reduction of the normal corporate income tax rate on the first $500,000 of a corporation's annual taxable in- come earned from carrying on an active business in Canada," Rotf leisch explains. The upshot is that a PC will pay tax at between 11 and 16 per cent (depending on the province of residence) on its first $500,000 of taxable income. The remain- ing tax is deferred, paid by the PC's shareholders only when they receive dividends, and then at a rate between 19 and 40 per cent. "The deferral is significant, especially for a taxpayer in the top marginal tax bracket, and means that approximately twice the funds are available for in- vestment, since in effect tax money is being retained in the corporation and invested," Rot- f leisch says. Paul Pape of Pape Barristers Professional Corporation agrees. "If you're prepared to leave some money in your practice, you can defer roughly 15 per cent of your income," he says. However, Pape adds that it's much easier to do that in a sole proprietorship or small law firm. "Once you have five or 10 partners, everybody's interests tend to be different, so what you tend to see is that some lawyers are getting the deferral by creat- ing their own personal corpora- tion to whom their income is distributed," he says. "The truth of the matter is that I see very few PC letterheads." As well, in a partnership structure, individual partners may have to share the small busi- ness deduction benefit among themselves. Finally, there are cer- tain restrictions on PCs, the most important being that the corpo- ration's shareholders must all be lawyers who are members of the same provincial or territorial law society. As for non-tax benefits, the main non-tax benefit to incorpo- ration in general is liability pro- tection. But a PC does not pro- vide the same protection. "It actually provides no addi- tional limitation on liability for professional negligence claims," Rotf leisch says. "But it can pro- vide some protection from credi- tors from whom the corporation has borrowed money." There are other non-tax bene- fits, however, such as the possibil- ity of making it easier to formu- late relationships with associates by making them independent contractors. Incorporation could also allow for greater f lexibility in setting up profit-sharing plans and in other employee compen- sation discussions. But lawyers contemplating incorporation should consider the increased costs and ad- ministration involved in doing so. And because shareholders must be lawyers, the creation of a PC restricts a professional's ability to income split immedi- ately (as opposed to obtaining a deferral) by paying dividends to family members. So there are advantages and disadvantages to incorporation. The question that remains, how- ever, is whether those who could take advantage have done so. 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