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 | The
Tax Benefits of Technical & Hygiene Service Corporations
by
David Chong Yen (Ontario Dentist Magazine, October 2001) |
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Overview
A Technical Service Corporation / Hygiene Service Corporation (THSC) are an entity
that operates the hygiene or technical service component of a dental or specialty
practice; for example orthodontic. Such corporations are separate businesses from
one's dental or specialty practice; hence, the THSC employs its own hygienist
and pays its fair share of rent, dental supplies, telephone, receptionist and
other business expenditures. The Royal College of Dentists and Surgeons of Ontario
(RCDSO) recently issued their position on the subject of TSC's in the form of
a Practice Advisory.
The THSC is taxed at approximately 20 per cent,
compared to the top personal tax rate of 44 per cent. Unlike a management company,
this type of corporation does not charge GST. It is my recommendation that the
dentist should not own the THSC, and typically, it is in fact owned by a discretionary
family trust. The beneficiaries of the trust usually include spouses, children,
parents, etc. As a trustee of this trust, the dentist can exercise control over
the THSC without owning it. The beneficiaries receive money via the trust at the
discretion of the trustee.
Planning
Prior to implementing
a THSC, determine the amount of hygiene or technical service income generated
by your practice. Your accountant will use this figure to perform a cost/benefit
analysis. Also, determine if you have individuals with whom you can split income.
For this, you will need to answer the following questions: Do you need all the
income generated by a THSC to pay your personal expenses? Of equal importance
is whether you have children attending university and/or parents requiring financial
support.
Next, obtain a valuation of your hygiene or technical service
business, then obtain legal and tax advice before implementing. Lastly, refer
to the RCDSO May 2000 Practice Advisory on technical service corporations.
Benefits of hygiene and technical service corporations
- Tax
savings and deferral
The THSC will save taxes, since it is taxed at 20 per
cent, compared with the top personal tax rate of 44 per cent. Profits remaining
in the THSC can be paid out as dividends to individuals.
A tax deferral means
that instead of paying taxes now, taxes are paid in a later year. This benefits
the taxpayer, since they can invest this money until such time as the tax bill
becomes due. A THSC facilitates tax deferral in two different ways:
a) With
a non-calendar year-end, the THSC can declare bonuses and realize a tax deduction
in the current year, yet the recipients of these bonuses will be paid and taxed
in a subsequent tax period.
b) Profits can be left in the THSC and used to
buy dental equipment and/or the building in which the dentist practices. Note,
however, that profits represent the amounts remaining after expenses have been
deducted from revenues, and therefore are taxed at a 20 per cent rate.
- Income
splitting
The THSC facilitates income splitting, as shareholders of the THSC
may include non-dentists such as spouses, children, parents, etc., who may be
in a lower tax bracket. Income splitting is the process by which income is deflected
from the higher income taxpayer into the hands of the lower income taxpayer. Hence,
tax savings can be achieved because individuals 18 years or older may receive
up to $23,000 in dividends tax-free, assuming they do not have any other income.
- Capital
gains exemption
Shares of a THSC qualify for the $500,000 capital gains exemption,
meaning a dentist will save taxes when he or she sells shares of their THSC, as
the first $500,000 of gains on these shares will be tax-free.
- Creditor-proofing
The THSC provides protection from the dentist's creditors, since the dentist will
no longer own the technical/hygiene components of the dental office.
- Estate
planning and probate fees
With a trust as shareholder of the THSC, estate
planning is facilitated and probate fees can be saved. A trust enables the dentist
to exercise control over the THSC, although he or she does not own it.
Pitfalls and Constraints
From the government's perspective, there are
acceptable and unacceptable ways of splitting income. Attribution rules are restrictions
implemented by the government to define the unacceptable ways of splitting income.
If these rules apply to your income-splitting transactions, then in most cases
the income, which was split and paid to the recipients, will be taxed in the provider's
higher tax rate, instead of the recipient's hand and at a lower tax rate. Your
tax advisor should be aware of these attribution rules and should be able to navigate
you around such pitfalls, such that income is taxed in the recipients' hands,
and therefore, in a lower tax bracket.
The government also frowns upon
the payment of dividends to individuals under 18 years of age, and any dividends
received by them will be assessed at the top tax rate, also known as the "kiddie
tax" rate. As a result of this disincentive, it is suggested that individuals
under 18 years should not receive dividends from the THSC.
Personal service
business rules should be avoided, as they essentially levy taxes at the 44 per
cent personal tax rate, compared with the 20 per cent THSC tax rate. Generally
speaking, personal service business rules may apply if the THSC employs family
members, which would result in higher taxes for the THSC. For this reason, where
family members work at the dental office, the dentist should employ them. This
is beneficial since the dentist is taxed a higher rate. Therefore, any expenses
charged to the dentist, including family salaries, will yield a larger savings.
General Anti-Avoidance Rules have been designed to provide taxation authorities
with the ammunition to challenge a tax strategy designed solely to save taxes.
However, as previously outlined, the THSC also facilitates estate-planning objectives.
Your lawyer should address conflict of interest guidelines and legal issues,
such as professional services. This area was discussed in a June 1999 RCDSO document
"Guidelines Respecting Conflict of Interest."
Professional income
should not be diverted away from the dentist and into the THSC, although technical
or hygiene income - which is separate and distinct from professional income -
may be funneled into the THSC.
THSC vs. Incorporation of a dentist
An introductory discussion of the incorporation of professionals was discussed
in the April 2001 issue of Ontario Dentist. Once the incorporation legislation
has been proclaimed, a THSC will be compatible with a professional corporation
and may be used in combination with one. However, it is important to remember
that they are separate and distinct entities.
While a THSC has the potential
to save a dentist significant taxes, a cost/benefit analysis should be done before
implementation, including seeking the opinion and direction of both a lawyer and
accountant specializing in this area.
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