Professional Corporations & Investment Restrictions: Guidelines and Options for Delivering a Healthy Return from Surplus Funds
Limitations on the activities of Medicine and Dentistry Professional Corporations
Over the past several years, as the tax benefits have become more widely known, the use of medicine professional corporations (“MPCs”) by physicians and dentistry professional corporations (“DPCs”) by dentists has become widespread. As time passes and the professional accumulates wealth in the professional corporation, issues have started to arise as to how this accumulated wealth can be used. More specifically, what are the limitations on the ability of the professional corporation to employ this accumulated capital in the operation of other revenue generating activities? In the case of MPCs, and as a result of both the proliferation of Advanced Rulings issued by CRA for medical partnerships and the constraints placed on the activities of MPCs due primarily to HST concerns, there has developed a misconception in some quarters that MPCs must restrict their activities to the provision of clinical services. Both these concerns beg the question “What can I use my professional corporation for?”
To answer this question, we must look at both the Business Corporations Act (“OBCA”) and the Regulated Health Professions Act (“RHPA”). Section 3.2(2)5 of the OBCA stipulates that
“5. 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. “
Regulation 39/02 Section 1(1)1) passed pursuant to the RHPA stipulates that:
“1. The articles of the corporation provide that the corporation cannot carry on a business other than the practice of the profession governed by the College and activities related to or ancillary to the practice of that profession.”
While these provisions vary slightly, the RHPA’s failure to reference the phrase “…including the investment of surplus funds earned by the corporation” is generally considered insignificant.
|Partnerships, Cost Sharing Arrangements and Tax Benefits|
|When to Incorporate Your Medical Practice|
What does seem clear is that the governing bodies do not want the professional corporations carrying on business activities unrelated to the practice of the profession. Some governing bodies have made this requirement more specific and have gone so far as to limit the type of investments that the corporation can make. For example, the College of Physicians and Surgeons of Newfoundland and Labrador takes the position that any investment activities by the professional corporation which would constitute the “carrying on business” other than the provision of medical services would be contrary to the Act. More specifically, they go on to state that “professional corporations ought not to be engaged in investment and business activities which are not related to the provision of the services of a medical practitioner and which for the purposes of the Income Tax Act (Canada) would give rise to incomes from a business”. The guidelines do authorize the professional corporations to hold real and personal property necessary for the provision of medical services, and allows them to invest in publicly traded stocks (provided it is less than 5% of the total publicly-traded share in any one corporation) mutual funds and similar types of investments generally available to the public.
The limitations established by the Newfoundland College seem consistent with the literal interpretation one can draw from the restrictions imposed under both the Act and the Regulations for professional corporations for health professionals. That is to say, the only “business” to be carried on by the professional corporation is the practice of the profession.
So where does this leave us? Not surprisingly, there is no case law on the interpretation of the phrase “activities related to or ancillary to the practice of that profession”. To look for meaning to these terms, we are left to further interpret the phrases “ancillary to” and “related to”. For our purposes, the most significant definition attributed to the word “ancillary” is something that is secondary, which follows a primary matter, and which cannot come into existence until the primary matter exists. Based on a review of the definitions, it would appear that the ancillary activities, including the investment of surplus funds, need not be related or connected to the practice of the profession. However if they are not related to the practice, they must be ancillary to or, in other words, subordinate to the primary purpose of practicing the profession. This interpretation seems to be consistent with discussions we have had with the College of Physicians and Surgeons of Ontario.
The phrase “related to” suggests that the activities are connected with or are in relation to the practice of the profession. From our discussions with various Colleges, it appears that the phrases “related to” and “auxiliary to” should be read disjunctively to one another. Consequently, activities may be related to a practice but not auxiliary and the reverse is also true.
Principles for Investing in Real Estate & Borrowing
The rules regarding investment in real estate are far from clear, particularly when the real estate being acquired is larger than that required to house the professional’s practice, is unrelated to his or her practice, or is rented out to another practitioner or unrelated business. It is interesting to note that one College has advised us that it takes the view that the professional corporation may own property used by members of the College to carry on the practice of that profession even though the professional corporation practices elsewhere. On the other hand, the College for Newfoundland and Labrador ostensibly prohibits any investment in real estate beyond that required for the MPC to carry on its medical practice.
Where the property is beyond what is needed by the professional to carry on his or her practice, unless the ownership and operation of the surplus real estate can be considered ancillary to the practice, it must qualify as an investment of “surplus funds”. From the phrase “surplus funds” one might reasonably infer that the investment is restricted to the actual funds on hand which are not required for the operation of the MPC or a DPC. The use of the word “surplus” has raised a question in the minds of many as to whether it is intended to somehow restrict or limit the ability of the DPC or MPC to borrow to finance the purchase of investments such as real property. Any corporation incorporated under the OBCA has the authority to borrow for any purpose, including an acquisition of real property. Consequently, how are we to give any meaning to the reference to “surplus funds” if it is not to be interpreted as a restriction on the MPC or DPC’s authority to borrow in relation to investments?
In many cases, the concerns regarding borrowing can be addressed through restricting the MPC or DPC’s share in the real estate investment to a proportionate interest based on the actual cash contributed with the professional or other related entity owning the balance of the investment as a co-owner. In this arrangement, it would be the other entity that would be borrowing the additional funds required. Structuring the investment in this way may however involve the MPC or DPC having to provide its guarantee of the obligations of the other co-owner. As in the case of borrowing, OBCA corporations have the power to provide financial assistance and to guarantee the obligations of others. There are some advisers who have suggested that the provisions of the RHPA and OBCA quoted above might restrict the MPC or DPC in exercising its authority to provide such financial assistance. Personally, I would expect to see more direct language if the drafters of the legislation intended that to be the case.
Another concern that may arise is at what point does the ownership and operation of a property become a “business”? As mentioned above, the Newfoundland College applies the test used by CRA. Other Colleges may follow suit, however there has not been any indication that any intend to do so.
Three Guidelines for Investing
Time will tell what interpretation the Colleges or indeed the courts might put on these phases in the future. At this point however, I believe it is fair to say that we can establish certain guidelines which may help a practitioner in determining whether certain activities come within the limitations.
- There is little doubt that activities such as preparing reports, teaching, medical research and the administration of these activities would either fall within the parameters of the practice of the profession itself, or be included in the phrase “related to the practice of the profession”.
- Entering into locum arrangements or other fee sharing or space sharing arrangements with other professionals would be ancillary, if not related, to the practice of the profession. It should be noted that, as neither the activities referred to in this item 2 nor those in item 1 are for clinical care, expect advise should be obtained to determine whether there are HST implications that need to be addressed.
- The purchase of real property from which you can carry on the practice of the profession would be an acceptable ancillary activity.
Consequences of Non-Compliance
So where does this leave us? What are the consequences of not complying with these limitations? Presumably the governing body could take steps to cancel the Certificate of Authorization of the professional corporation, although such steps appear drastic considering the reluctance on the part of the governing bodies to provide any guidance as to what are permitted activities. Unless there is any possible consumer protection or public health implications, it is likely that the governing bodies will only take action in the most egregious situations.
It also seems unlikely that contravening these limitations will result in any action by CRA. In the first place, it is doubtful that CRA has any grounds on which to base a challenge when one takes into consideration subsections 3.2(3) and 17(3) of the OBCA, which specifically provide that no act done on behalf of a professional corporation is invalid merely because it contravenes this Act or any limitation on its activities set out in its Articles of Incorporation.
Alternative Options for Making Investments
In addition to the concerns raised above regarding the possibility of disciplinary action being brought by the appropriate college based on an MPC or DPC getting involved in other business activities or investments in violation of the limitations discussed above, there are other reasons why it is generally advisable to have these investments through some other entity. If the professional was to establish another business corporation (“SisterCo”) the SisterCo would not be a professional corporation and therefore not subject to the same constraints on who can be a shareholder the possible restrictions on borrowing or providing financial assistance through giving a guarantee. This would allow the use of more conventional estate planning and tax planning techniques including shares being held by a discretionary family trust and allowing shares to be held by non-family members. In order to fund these SisterCos, there are a number of alternatives available. The most straightforward is to simply have the MPC or DPC loan the “surplus funds” to the SisterCo and take back a note or to invest the surplus funds to SisterCo through the purchase of shares. More aggressive strategies to transfer the surplus funds to SisterCo involve the use of stock dividends and share redemptions. Although more aggressive, these latter strategies have the advantage of transferring the surplus funds to SisterCo without the MPC or DPC retaining any interest in SisterCo, either as a debtor or shareholder, and this can be advantageous from a liability perspective. It can also be an effective technique for removing surplus funds in the event that the shares in the DPC or MPC are being sold.
In closing, it’s fair to say that there is a fair amount of confusion surrounding the meaning of the limitations on the activities that are permitted for DPCs and MPCs in Ontario, and this confusion is not limited to the dentists and the physicians. Each situation will be different and it is recommended that no investments of the type discussed above be undertaken without having your particular situation looked at by an adviser well-versed in this area. Besides simply ensuring that you stay onside with your College, you will also want to make sure that the structure provides you with the best opportunity to minimize your income tax burden and maximize future capital appreciation.