Published: June 12, 2020
Last Updated: June 12, 2020
The Tax and other Benefits & Challenges of Practicing Law in Ontario As a Professional Corporation – Canadian Tax Lawyer Analysis
Introduction – Business Structures & Professional Corporations
Under the Law Society Act (the “LSA”) and the Business Corporations Act (Ontario) (the “OBCA”), lawyers and licensed paralegals are permitted to practice law and provide legal services in Ontario through a sole proprietorship, general partnership, limited liability partnership or a professional corporation. It is highly recommended for lawyers and paralegals to explore the income tax and other benefits and challenges of each business structure prior to selecting the one that best fits their needs. For the purpose of simplicity, this article will focus on the benefits and challenges associated with practicing law in Ontario through a professional corporation.
The LSA and the OBCA define “professional corporation” as a corporation that is incorporated or continued under the OBCA and which holds a valid certification of authorization issued under the Act governing the profession. In Ontario, lawyers and paralegals who are intending to form a professional corporation must incorporate under the OBCA and apply to the Law Society of Ontario for a certificate of authorization.
Benefits of Incorporating a Legal Practice in Ontario
Lawyers and paralegals who incorporate their law practice may benefit from effective tax planning strategies that are only available to professional corporations. For example, professional corporations provide income tax benefits including income tax deferral, lower income tax rates by way of retaining earnings in the corporation or in some cases through income splitting when profits are ultimately distributed. In addition, lawyers and paralegals who are practicing law in a small law firm or as a sole proprietorship who are intending to form a professional corporation can undertake a tax-free rollover under section 85 of the Income Tax Act to move their existing business assets to the corporation while avoiding income taxes payable as a result of the transfer of assets into the Corporation.
Another tax planning benefit to incorporating your law practice in Ontario is having the option to set up an Individual Pension Plan (“IPP”). Considering that self-employed lawyers do not have a normal pension plan, setting up an IPP allows lawyers to save for their retirement. IPPs can provide significantly higher contribution rates than a Registered Retirement Savings Plan (“RRSP”) and they permit lawyers to make an additional one-time lump-sum contribution. This means that if lawyers are unable to contribute to their IPP during their first years of practice, they can carry forward their contribution room and make a one-time large lump-sum contribution in the future when their earnings increase.
A Health and Welfare Trust (“HAWT”) (also referred to as a Health and Welfare Plan) is another tax planning arrangement available to professional corporations. Lawyers who are practicing law under a professional corporation can set up a HAWT through which they can provide their employees with reimbursements for medical and dental expenses. As a tax planning benefit, HAWTs allow deductibility of the contributions made to the plan for the professional corporation.
Rules and Challenges of Incorporating a Legal Practice in Ontario
Despite the above-mentioned benefits associated with incorporating a law practice as a professional corporation, there are challenges associated with selecting this business arrangement. For instance, the OBCA includes restrictions that apply to professional corporations that don’t apply to business corporations pertaining to shareholders, directors, corporation name, the services provided through the corporation and professional corporate liability.
When a law practice is incorporated, the resulting professional corporation is recognized as a separate legal entity. Shareholders (lawyers and paralegals) of this entity must also be directors and officers of the legal entity and must be licensed to practice law and to provide legal services in Ontario (LSA Subsection 61.0.1(5); OCBA Subsection 3.2(2)). All issued and outstanding shares of the legal entity must be legally and beneficially owned, directly or indirectly, by one or more persons who are licensed to practice law and to provide legal services in Ontario (LSA Subsection 61.0.1(4); OCBA Subsection 3.2(2)). Under the LSA, shareholders have an obligation to notify the Law Society of Ontario of any changes pertaining to the shareholders of the corporation (Section 61.0.3).
The rights, privileges and powers of shareholders in a professional corporation are also restricted. Subsection 3.2(4) of the OBCA provides that an agreement that vests in a person other than a shareholder of the professional corporation the right to vote such rights attached to a share of the corporation is void. As a result, all voting shares must belong to members of the legal profession who are shareholders, directors and officers of the professional corporation. In addition, a unanimous shareholder agreement is void unless each shareholder of the corporation is a member of the professional corporation (OBCA Subsection 3.2(5)).
The LSA and the OBCA provide that a professional corporation shall not utilize a number in place of a proper name. The name of the corporation must include the words “professional corporation” and shall comply with the rules respecting the names of the corporation set out by the Law Society of Ontario, its regulating Act and By-laws (LSA Subsection 3.2(2); OBCA Subsection 3.2(2)). In addition, where a corporation ceases to be a professional corporation, it must change its name to remove the word “professional” from its name (LSA Subsection 3.3(4); OBCA Subsection 3.3(4)).
Professional corporations are corporations that are limited to providing professional services. The articles of incorporation must include a clause prohibiting the professional corporation from carrying on business or providing services outside the practice of law (OBCA Subsection 3.2(2); LSA Subsection 61.0.1(5)). In addition, the articles of incorporation shall not be drafted in a manner that restricts the professional corporation from providing legal services or carrying on business related to the practice of law.
Unlike business corporations, the liability in a professional corporation is not limited to the corporation, such liability extends to the shareholders, employees and agents of the corporation. Section 3.4 of the OBCA provides that acts of a professional corporation shall be deemed to be the acts of its shareholders, employees and agents and that such individuals are “jointly and severally liable” with the corporation for all professional liability claims against it, provided that the error or omission occurred during the time when the individual was a shareholder, employee or agent of the corporation (OBCA Subsection 3.4(4)). Further, where a professional corporation is a partner in a partnership or a limited partnership, the shareholders of the corporation have the same liability as the partnership or limited partnership as they would have if the shareholders were partners with the corporation (OBCA Subsection 3.4(6)).
The most significant downfall in incorporating a law firm pertains to the cost. Professional corporations can create initial and ongoing administrative costs including initial reporting and annual reporting costs as required by the Law Society of Ontario, as well as costs associated with setting up and maintaining an IPP and preparing and filing the T2 Corporate Income Tax Return.
Tax Tips – Choosing a Professional Corporation
For some Ontario lawyers and licensed paralegals, the beneficial options available in a professional corporation far outweigh the downside to incorporating. Nevertheless, incorporating a law firm is a complex process that requires compliance with the OBCA as well as the Law Society of Ontario, its regulations, by-laws and the Rules of Professional Conduct. Therefore, it is highly recommended for lawyers and paralegals intending to incorporate their law practice to not only consider the benefits and challenges associated with professional corporations but to also seek advice from an experienced Canadian tax lawyer. If you are considering incorporating your legal practice or you have questions pertaining to tax treatment of incorporating a professional corporation, please contact our tax law office to speak with one of our experienced Certified Specialist in Taxation Canadian tax lawyers.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."