John, a successful health professional, decides to purchase a building where he will operate his practice. He found an ideal location and arranged financing with his bank. However, he cannot decide whether his wholly-owned Professional Corporation (PC) should purchase this property, or if he should form a new holding company (Holdco) to purchase this property, which would lease it to the PC.
In the case of the PC owning the property:
- administrative costs and professional fees would be reduced as there would be no need to prepare a set of financial statements and tax returns for a second corporation; and
- no on-going GST/HST filings would be required in respect of the property since there would be no rental income or GST/HST collected.
However, if John can sell his practice in the future, and if he decides to do so, he may not be able to utilize his lifetime capital gains exemption (LCGE). Ordinarily, the use of the LCGE on a sale of shares of the PC could save John more than $200,000 in personal income tax. In addition, if the PC owns the property, the fair market value of its shares are significantly higher, and therefore, it may detract potential buyers that are only able to obtain financing for the professional practice itself. This may force John to sell assets of the practice and forego the utilization of the LCGE. Finally, if John sells the shares of his PC while it owns the real estate, he would lose the ability to earn steady rental income in his retirement years.
Owning the property in Holdco would provide John with more flexibility; he could sell the practice (without having to sell the property) and may be able to utilize the LGCE on a sale of PC shares. However, as mentioned, maintaining two separate corporations requires additional administration and professional fees. In addition, there could be an ultimate GST/ HST cost to Holdco owning the property.
LCGE – A potential tax benefit
If John can sell his practice and structure the transaction as a sale of the shares of his PC, the shareholders of the PC may be able to utilize their LCGE. To qualify for the LCGE, the shares of the PC must be shares of a Canadian-controlled private corporation that has used more than 50 per cent of the fair market value of its assets in an active business for the past 24 months and 90 per cent on the date of the sale. Generally, this should not be an issue if the PC owns the property and uses it exclusively for John’s practice. However, what if the PC buys a property, decides to use a portion of the space for John's health practice, and rents the remaining space to one or more tenants? If the PC owns the property, and John does not use a significant portion of the space for his practice, the shares of the PC may not qualify for the LCGE. This could potentially result in John and other shareholders each losing out on $200,000 of tax savings on a sale of the shares of the PC. This predicament could be avoided if Holdco owns the property, or if it is owned by the PC and John’s practice exclusively uses the property.
GST/HST – A potential tax cost
If the PC purchases the property, the purchase would be subject to GST/HST. Assuming the PC has not registered for GST/HST, the PC would pay the GST/ HST on closing to the vendor. Conversely, if Holdco purchases the property, Holdco would be required to register for GST/ HST. It would then have to self-assess the GST/HST owed at the time of purchase, but it would be entitled to a corresponding equal input tax credit (ITC) (i.e. refund) for the GST/HST self-assessed such that the net GST/HST it has to pay is $nil.
As a registrant, Holdco would be required to collect GST/HST on the charged rent to the PC. The PC would generally not be able to claim an ITC for the GST/HST it pays on the rent since the majority of services it provides are not subject to GST/HST. Over time, the total amount of GST/HST the PC would pay on its rent to Holdco may exceed the GST/HST it would have otherwise paid if it purchased and owned the property. Therefore, while there is a deferral of the GST/HST to be paid on the purchase of the property, there can be an ultimate GST/ HST cost if the PC rents the property from Holdco. This cost would depend on the length of the PC tenancy and the fair market rent charged over that time.
There is no one-size-fits-all solution for health practitioners when deciding whether a newly formed holding company or the PC should acquire real estate. The right solution for you depends on your specific situation. A discussion with your professional advisor in advance of a real estate purchase is crucial to ensure you are investing strategically.
Contact your Crowe Soberman advisor today if you are contemplating a real estate investment as part of your practice.
This article has been prepared for the general information of our clients. Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article. Please note that this publication should not be considered a substitute for personalized tax advice related to your particular situation.