Use And Abuse Of Professional Corporations

There are substantial tax savings available and, for some professionals, opportunities for income splitting. Budget 2016, however, introduced special anti-avoidance rules to prevent professionals from undermining the small business deduction rules, and these should be factored into professional corporation structures that involve partnerships. The corporate rules vary by province and territory. The federal tax rules, however, apply across the board.

A professional corporation (PC) allows professionals — such as, doctors, dentists, lawyers, and accountants — to provide their services to clients through a corporate entity, rather than personally. The corporate entity must be created under the auspices of provincial or territorial corporate statutes, and comply with rules determined by provincial regulatory bodies. The rules typically control the structure and operation of such entities to ensure that they do not violate, or circumvent, professional codes of conduct and practice.

MEANING OF PROFESSIONAL

Roscoe Pound defined a professional as a person "pursuing a learned art as a common calling in the spirit of public service — no less a public service because it may incidentally be a means of livelihood".1

Professions are generally regulated by independent bodies, determine their own rules of conduct and behavior, and typically protect themselves with monopolistic barriers. Daniel Duman identified the English bar as "the classic English profession as measured by nearly all the criteria usually associated with professionalism: autonomy from external interference, monopoly over practice, the possession of esoteric knowledge and skills, corporate unity and a position of dominance over a clientele dependent upon professional advice".2

For tax purposes, the definition of a "professional" is much broader than any of the traditional senior professions (lawyers, doctors, accountants, engineers, architects, etc.). A profession includes almost any occupation, other than individuals who engage in a personal services business3 as an "incorporated employee".4 Thus, with the limited exception for incorporated employees who earn personal service business income, almost any individual can form a professional corporation for tax purposes, and derive the appropriate tax benefits.

RATIONALE

The PC rules level the playing field for professionals so that they can operate in the same way as other individuals. However, there is one significant difference between professionals and nonprofessionals: Shareholders of PCs cannot limit their liability for negligence or malpractice, and they remain jointly and severally liable for all professional liability claims against them. This makes the choice of form of practice an important decision. Large law and accounting partnerships are typically better off practicing as limited liability partnerships (LLPs) in order to limit the personal malpractice exposure of their partners. On the other hand, sole proprietors, and small partnerships may be better off practicing as PCs for the tax advantages.

FUNDAMENTAL BUSINESS CONCEPTS

The fundamental business model of a professional corporation (PC) is that the corporate entity provides its services through an employee, who may also be its principal shareholder. The principal business imperative of a professional service corporation is that the entity must provide the services to, and contract with, the client or third party, even though it is the professional who personally delivers the service. Thus, the professional is the agent of the corporation. The corporation cannot be the agent of the professional.

Hence, a professional corporation should conduct itself like any other business corporation. This means that it is the PC that should:

Enter into all contracts, including employment contracts; Enter into leases and contracts to acquire services; Operate its bank accounts; Promote itself in advertising; and Prepare financial statements. In essence, the PC must deliver the services.

ENABLING STATUTES

Professionals can incorporate in all Canadian common law provinces under their respective corporate statutes. Although the various enabling statutes are similar, it is imperative that one consult the relevant applicable statute in the province of residence. In Ontario, for example, the Business Corporations Act, RSO 1990, c. B-16 (OBCA) is the governing statute for PCs.

Section 3.1 OBCA provides that:

"Where the practice of a profession is governed by an Act, a professional corporation may practise the profession if,

that Act expressly permits the practice of the profession by a corporation and subject to the provisions of that Act; or the profession is governed by an Act named in Schedule 1 of the Regulated Health Professions Act, 1991, one of the following Acts or a prescribed Act: Certified General Accountants Act, 2010. Chartered Accountants Act, 2010. Law Society Act. Social Work and Social Service Work Act, 1998. Veterinarians Act. 2000, c. 42." All of the common law provinces now allow lawyers to practice their profession through PCs. Subsection 3.2(2) OBCA sets out the structural and organizational conditions for creating PCs, as follows:

"Despite any other provision of this Act but subject to subsection (6), a professional corporation shall satisfy all of the following conditions:

All of the issued and outstanding shares of the corporation shall be legally and beneficially owned, directly or indirectly, by one or more members of the same profession. All officers and directors of the corporation shall be shareholders of the corporation. The name of the corporation shall include the words "Professional Corporation" or "société professionnelle" and shall comply with the rules respecting the names of professional corporations set out in the regulations and with the rules respecting names set out in the regulations or by-laws made under the Act governing the profession. The corporation shall not have a number name. The articles of incorporation of a professional corporation shall provide that the corporation may not carry on a business other than the practice of the profession but this paragraph shall not be construed to prevent the corporation from carrying on activities related to or ancillary to the practice of the profession, including the investment of surplus funds earned by the corporation." With the exception of physicians and dentists, where special rules apply5, subsection 3.2(2)(1) effectively precludes most other professions from splitting their professional income with family members who are not also members of the same profession. Thus, the rule prevents most lawyers from taking advantage of the income splitting tax benefits that are available to other businesses conducted through private corporations.

VOID VOTING AGREEMENTS

Voting agreements that vest powers or proxies in non-members of the profession are void if they remove powers from the shareholder, as are unanimous shareholders' agreements if all of the shareholders are not members of the PC (subs. 3.2(4) and (5) OBCA).

CONTINUED EXISTENCE OF CORPORATION

Subsection 3.3(1) OBCA provides for the continued existence of a PC despite:

the death of a shareholder; the divorce of a shareholder; the bankruptcy or insolvency of the corporation; the suspension of the corporation's certificate of authorization or other authorizing document; or the occurrence of such other event or the existence of such other circumstance as may be prescribed. UNLIMITED LIABILITY

A professional practicing...