The Incorporated Physician's Corporation, and What Sits Inside It

Retained earnings are the part of your practice income that your corporation earned, paid corporate tax on, and kept. What happens to them next decides much of what incorporation is worth to you: how the money is taxed while it sits there, how the income it earns is measured against a federal rule on the small business rate, and what it costs to take out later.

Here is the short version. A practising physician's corporation can earn active professional income taxed at the low small business rate, and it can also hold investments. Realized investment income inside it is taxed at high corporate rates, and part of that tax is refundable later. Federally, once that investment income passes $50,000 in a year, the next year's small business limit starts to shrink. A life insurance policy that stays exempt changes how growth inside it is measured, and nothing more than that. Whether any of it helps you depends on your corporation's own figures.

Retirement questions, such as the mix of salary and dividends, the registered room it creates and the order of withdrawals, are covered under retirement planning for a physician. The wider corporate picture is under business owners. What follows is about the corporation itself and what sits inside it.

What are retained earnings, and what are they not?

Retained earnings are professional income that was earned, taxed at corporate rates, and left inside the corporation. The word retained does the work. The money has not been paid out to you, so the personal side of the tax has not happened yet.

That makes a corporate balance different from money in your own account. A dollar in the corporation is not an after-tax personal dollar. What it costs to bring it out depends on the route: a salary, a taxable dividend, a capital dividend from the corporation's capital dividend account, or the repayment of money you lent the corporation each has its own treatment. Some routes are taxed in your hands. A properly elected capital dividend paid to a shareholder resident in Canada is not. The corporation's tax accounts decide which routes are open and how much can go through each one.

Retained earnings are also not a pension. There is no employer, no matching contribution and no vesting. What is there is what was put there, less what it cost to hold. And they are not productive on their own. Left in cash they earn little. Invested, they earn income that the corporation reports every year.

Deferral is the real advantage. Professional income kept in the corporation is taxed first at corporate rates, and the personal tax waits until the money is paid out. That is worth having. It is still a postponement of personal tax, and its size depends on your province, your income and how long the money stays in.

Is your corporation a practice, a portfolio, or both?

For as long as you practise, your corporation earns active professional income. That is the income the small business deduction applies to. In plain terms, the small business deduction is the lower corporate rate on the first slice of active business income each year, and the business limit is the size of that slice.

The same corporation can also hold investments bought with surplus. Those investments raise a second, separate question, because the income they earn is taxed under different rules and is measured against the business limit. Your practice income and your portfolio are two tax questions that happen to share one corporation.

After you stop practising, the balance shifts. A corporation with no active income left is, in tax terms, mostly in the business of investing, and the passive income rule then has little active income to reduce. The questions move from the small business rate to how the money comes out over the years.

Four sets of rules can touch corporate surplus, and they deserve a name before anyone talks about a product. The first is the small business deduction and its business limit. The second is the passive income rule, which reduces that limit. The third is the personal services business rules, which deny the small business deduction where a corporation's work would otherwise be an employee's; your accountant checks whether they touch any of your income. The fourth applies in Quebec: a condition on the hours paid to employees that can reduce the provincial small business deduction on its own.

How is investment income inside the corporation taxed?

Realized investment income is taxed at high corporate rates. That covers interest, foreign income, rent from a passive holding, and the taxable part of a capital gain once an investment is sold. Part of that tax is refundable. When the corporation pays you taxable dividends, it can recover 38⅓% of the dividends paid, up to the balance of its refundable dividend tax on hand (Income Tax Act, subsection 129(1)).

Dividends the corporation receives from other Canadian corporations follow a separate path. They can attract a refundable tax under Part IV of the Act, which feeds the same refund account (subsection 129(4)). Unrealized gains are not taxed at all until the investment is sold. When a gain is realized, the part that is not taxed is added to the corporation's capital dividend account (s. 89(1), paragraph (a)).

So the yearly cost of a corporate portfolio is not simply the headline rate. It depends on what the portfolio holds, how often it sells, and when dividends are paid out. Your accountant can show you the actual figures from your returns.

What is the passive income rule, with its numbers?

The rule sits in paragraph 125(5.1)(b) of the Income Tax Act. The CRA's T2 guide gives the federal business limit as $500,000 for a Canadian-controlled private corporation that is not associated with any other corporation. That limit shrinks when the corporation and every corporation it is associated with together earned more than $50,000 of adjusted aggregate investment income in their tax years that ended in the previous calendar year. The CRA puts the end point plainly: the business limit is nil once that combined income is more than $150,000.

The formula takes five times the amount above $50,000, scaled to the corporation's own limit. For a corporation with the full $500,000 limit, each dollar of investment income above $50,000 takes $5 off the next year's limit. A second reduction applies to corporations with large taxable capital, and the CRA uses the larger of the two.

Illustrative example. Assume your corporation has the full $500,000 limit, no associated corporations, $70,000 of adjusted aggregate investment income in its tax year that ended last calendar year, and $450,000 of active professional income this year. The reduction is five times ($70,000 less $50,000), which is $100,000. This year's federal business limit is therefore $400,000. Of the $450,000 of active income, $400,000 can be taxed at the small business rate and $50,000 is taxed at the general corporate rate. Had the investment income been $150,000, the reduction would have been five times $100,000, or $500,000, and the limit would have been nil.

Adjusted aggregate investment income is a defined measure, not everything you might call passive income. It starts from the corporation's investment income, leaves out gains on assets used in its active business, and brings in amounts in respect of a life insurance policy that are included in the corporation's income for the year (s. 125(7), which adopts that wording from the definition of income or loss in subsection 129(4)). The last point matters for anyone considering a corporate policy, and it comes back below.

The rule does not take money out of the corporation directly. It moves active income from the small business rate to the general rate. Income taxed at the general rate adds to the corporation's general rate income pool, defined in s. 89(1), which lets it pay eligible dividends, taxed in your hands at lower personal rates than other dividends. So part of the cost is a smaller deferral rather than a permanent extra tax. How much is lost on balance is a calculation for your accountant.

Which provinces follow the passive income rule?

Provinces decide for themselves, and the answer changes the stakes.

Revenu Québec confirms that the Quebec business limit is reduced gradually when the adjusted aggregate investment income of the corporation and its associated corporations is between $50,000 and $150,000. It also confirms that the reduction of the Quebec small business deduction rate based on the number of remunerated hours stays in place. In plain terms, a corporation that pays few hours of employee work can see its Quebec small business deduction reduced, whatever its investment income. If you practise in Quebec with little paid staff, ask your accountant where the Quebec deduction stands before you weigh the passive income rule at all. Federal rules apply everywhere, and a Quebec corporation also files with Revenu Québec.

What does an exempt life insurance policy change about that measure?

Three terms first. The cash surrender value is the amount the insurer would pay if the corporation, as owner, cancelled the contract, less any loans owing. Paid-up additions are small blocks of extra paid-up coverage bought with policy dividends or extra premium, each with its own cash value. The adjusted cost basis is the policy's tax cost under section 148 of the Income Tax Act; it rises with premiums paid, falls over time under a formula in the Act, and the insurer can report it to the owner.

An exempt policy is one that passes a test in section 306 of the Income Tax Regulations. In plain terms, the test limits how much savings the policy can build compared with a benchmark policy for the same coverage. Subsection 12.2(1) of the Act requires an owner to include accumulating growth in income every year for a policy that is not exempt. For an exempt policy, that yearly inclusion does not apply.

On our reading, growth inside an exempt policy that is not included in the corporation's income in a year does not add to its adjusted aggregate investment income for that year. That is the whole technical claim. It is a statement about measurement and timing, not about return, and nothing in it says the policy grows faster than a portfolio.

It changes when money comes out. A surrender, a partial surrender and a policy loan are each a disposition for tax purposes (s. 148(9)). The part of the proceeds above the adjusted cost basis immediately before is income to the corporation that owns the policy (s. 148(1)), and a partial surrender is measured against a proportional part of the basis (s. 148(4)). Because adjusted aggregate investment income includes policy amounts included in income, a taxable policy gain can count toward the passive income measure in the year it arises. A policy loan above the basis can therefore raise the next year's reduction. Ask your accountant to model it before any loan or surrender.

Exempt status is a condition the policy has to keep, not a feature it is born with. A design that ignores the test, or a later change that breaks it, can produce tax nobody planned for, and a policy that stops being exempt is treated as disposed of (s. 148(2)(d)). Confirm the position with the insurer and your accountant before applying, and again before any change to the contract. The mechanics are set out under tax-deferred growth and the exempt test.

What does a corporate policy not do?

It does not create a deduction in the ordinary case. Premiums are generally not deductible to the corporation. A limited deduction can exist under paragraph 20(1)(e.2) of the Income Tax Act where a policy is assigned as collateral for a loan used in the business, and only under the conditions in that paragraph. Your accountant applies them, and which part of the premium is deductible explains them.

It does not make corporate money personally available. When the corporation owns the policy, a policy loan is an advance from the insurer to the corporation. Getting that money to you is a second transaction, such as a salary, a dividend or the repayment of money you lent the corporation, and it has its own tax.

It does not remove the interest cost. The insurer charges interest on a policy loan, and that interest is owed to the insurer and paid to the insurer. The insurer sets the rate and may change it.

It does not replace disability coverage. For a physician, the ability to work is the asset every other plan quietly assumes will continue. Permanent life coverage bought while disability coverage is thin puts the priorities in the wrong order.

And it is not an investment. A specially designed, high-cash-value, participating whole life insurance policy is life insurance. Do not choose one on a dividend scale interest rate or on a promise to beat a portfolio. A fair comparison sets the policy's guaranteed and illustrated cash values, its death benefit and its costs against an appropriately taxed portfolio funded from the same corporate dollars over the same years. The answer depends on whether you have a lasting need for the death benefit and on the assumptions used. A dividend scale interest rate is not your return.

How does borrowing against a corporate policy work?

There are three different transactions here, and they get described as one. For each, name who lends, who owes whom, who receives the interest and what is pledged.

A policy loan lowers the adjusted cost basis. Repaying it restores the basis and can give a deduction under paragraph 60(s) in the year of repayment, limited to amounts previously included in income. That is a deduction, not a refund of the earlier tax, and it does not arise without repayment. More detail is under policy loans and when a policy loan becomes taxable.

If a loan grows until it overtakes the value securing it, the contract can end under its terms. For tax, the proceeds of that disposition are the cash surrender value less the loans owing, so income can arise even when little or no cash is paid out. The rule that excuses a lapse reinstated within 60 days after the end of the calendar year is written for premiums left unpaid. Whether it can help when a loan caused the end is a question to put to the insurer and the accountant in writing. When the margin is narrow, check the loan balance more often than once a year.

With a collateral loan, the corporation stays the owner of the policy. The lender holds the assignment, which is a right to be repaid from the policy, and the assignment is released when the loan is repaid. The lender's approval is needed at the start, and its terms can change under the loan agreement. How an insurer loan and a collateral loan each affect the credit at death is explained under the capital dividend account.

The third route deserves a slower look. When a corporation pledges its policy for your personal loan, the CRA can treat the arrangement as a benefit conferred on you as a shareholder under subsection 15(1) of the Act. Whether a benefit arises, and how much it is, depends on the facts and the documents. Ask your accountant for a written opinion before anyone signs an assignment.

Who owns the policy, who pays, and who is named?

Three decisions travel together: who owns the contract, who pays the premium, and who is named as beneficiary. Make them together, because a mismatch changes the tax result. The full treatment is under corporate-owned life insurance.

Where the corporation pays a premium on a policy that you own, or one payable to your family, the CRA can include a benefit in your income under subsection 15(1). Different owners, payers and beneficiaries can each change the outcome. Have your accountant document the proposed parties and the benefit analysis before the application is signed.

Whether the policy belongs in the professional corporation, in a holding company or with you personally is not a default setting. Each produces a different result at death, on a reorganisation and on a wind-up, and each has its own effect on the capital dividend account and on the share tests for the capital gains exemption. Moving surplus to a holding company does not, by itself, take it outside the passive income rule, because the investment income of associated corporations is counted together. Your accountant and your lawyer weigh the options on your facts.

Provincial rules on who may own the shares of a medical professional corporation apply; ask the college and a lawyer before any structure is chosen.

What happens at death, and how does the capital dividend account work?

The capital dividend account is a notional tax account kept by a private corporation. It tracks specified amounts that may support tax-free capital dividends, and it does not hold cash. The untaxed part of realized capital gains, net of losses, goes into it. So does life insurance received because of the death of the person insured, less the policy's adjusted cost basis immediately before the death (s. 89(1), paragraph (d)).

That has three consequences. The credit is the death benefit less the basis, not the whole benefit, and the basis changes over the life of the contract, so the credit cannot be read off an illustration today. An insurer policy loan still outstanding at death is deducted from the death benefit, which reduces the amount the corporation receives and the credit with it. And the account is shared across the corporation's whole history, so other gains, losses and earlier capital dividends move it.

Paying a capital dividend needs an election under subsection 83(2), filed on form T2054 by the earlier of the day the dividend becomes payable and the day it is first paid; a Quebec corporation also files form CO-502 with Revenu Québec. Paid to a shareholder resident in Canada, a properly elected capital dividend is not included in income. A shareholder who lives outside Canada is generally subject to Part XIII withholding tax on it. Your accountant calculates the balance before any dividend is declared, and the rest is covered under the capital dividend account.

Who decides, and who answers which question?

You decide. Your accountant advises on the tax position of your corporation. A licensed insurance representative assesses whether a policy meets a real insurance need and explains what it does and does not do. In Quebec, sections 27 and 28 of the Act respecting the distribution of financial products and services require a representative to inquire into your situation to assess your needs, and to describe the proposed product in relation to those needs before the contract is made. A lawyer, or in Quebec a lawyer or notary, drafts and reads the documents.

When you bring a proposal to your accountant, the briefing on accountants and the strategy they are asked to approve sets out what to bring with it.

Infinite Financial Sovereignty®, and whose idea is the underlying one?

The underlying idea is not this practice's. The financing approach Nelson Nash named The Infinite Banking Concept® is a mark of Infinite Banking Concepts, LLC, set out in his own writing, and neither Canadian Wealth Creation Centre Inc. nor Jose Salloum is affiliated with that organisation or endorsed by it.

Infinite Financial Sovereignty® is a registered trademark of Jose Salloum for a narrower discipline: that an entity with durable surplus should be its own source of capital rather than a permanent customer for somebody else's.

For an incorporated physician the application is unusual. A medical professional corporation may have less to finance than an operating business, and there may be no equipment cycle like the one a dental practice carries. Where that is so, the question is where surplus is held and how it is measured, not who finances the next purchase.

That is why a presentation written for an operating business deserves a careful reading when it reaches a physician.

Why can a proposal built for another business miss your facts?

Material written for an operating company assumes an active business with a buyer for its shares and a regular financing need. A physician's corporation may have none of those in the same form. A proposal that does not adjust for that has described someone else.

Ask whether it deals with your passive income position, including the effect of any policy gain on the measure. Ask whether it treats a premium as a deduction, or a death benefit as tax-free, without the conditions that make either statement accurate. The unqualified version is the one that produces an assessment.

And ask whether it names who decides. Insurance advice and corporate tax advice are different licences and different professions. A proposal that does not send the tax questions to your accountant has kept them, and that is the problem, not a shortcut.

What happens to the corporation, and the policy, when practice ends?

Do not build a retirement plan around an assumed sale of your shares. Some physicians stop practising and draw money out of the corporation over years, some reorganise, and others have a different transaction. The share ownership rules for medical professional corporations limit the choices, and a lawyer and an accountant should model your actual exit.

The capital gains exemption matters only if a qualifying sale of the shares is realistic. The share tests look at how much of the corporation's assets serve an active business, at the time of sale and over a period before it, and a policy's cash surrender value and a portfolio can both weigh against them. The details are under an exit in ten years. Ask your accountant whether the exemption is realistic for you before giving it weight.

A corporate policy does not dissolve with the corporation. If the corporation is wound up or reorganised, the contract has to go somewhere, and moving ownership of a policy has tax consequences that depend on who receives it and on what terms. Decide at the start what would happen to the contract on a wind-up, a reorganisation or a move to another province, with your accountant and your lawyer together.

The corporation may also outlive the practice by decades. Whatever sits inside it has to work for someone who is no longer billing, possibly for a spouse and possibly for an estate. A structure that only works while you are practising is half a structure.

Where would the premium come from?

From surplus that already exists in a normal year. Not from a good year, and not from money that is already doing a necessary job. How much premium a corporation can carry is a test rather than a figure, worked through under funding premiums from corporate cash flow.

Never buy a policy to fund a business need you expect in the next few years. A policy is life insurance first, and depending on the design its early cash surrender values can be well below the premiums paid, or nil.

Registered plans such as an RRSP or a TFSA do a different job from a corporate policy. The practice gives no order between them. Questions about them belong with a professional licensed for them, working from your own figures.

Expensive debt is a separate question. Paying it down gives a saving equal to the interest avoided, with no death benefit attached, and that certainty deserves weight beside anything projected.

And the corporation may be your only reserve for a leave, a slow year or a change of practice. Committing that reserve to a premium that runs for decades is a decision with consequences. Keep the reserve you need, and make the decision knowing the cost.

Who does a corporate policy not suit?

A corporation without durable surplus in a normal year. No design makes a premium sustainable from money that is not there.

A physician who may need the money back within a few years. Depending on the design, early cash surrender values can be below the premiums paid, and an early surrender turns that gap into a loss. Ask for the guaranteed cash surrender value year by year beside the cumulative premiums before you decide.

A physician whose horizon is short for another reason, such as stopping practice soon, so that the early costs have little time to be recovered. There is no universal break-even year. The illustration for your own design shows where it falls, under its stated assumptions.

A physician without adequate disability coverage, or one whose accountant has not reviewed the structure. Either is a reason to stop, not a detail to tidy afterwards. If the answer is no, that is a good outcome too.

What stands behind the guarantees?

The guaranteed values are the insurer's contractual promise, so they rest on its solvency, and no government backs them. An insurer incorporated federally is supervised by the Office of the Superintendent of Financial Institutions. One incorporated in a province is supervised by that province, through the AMF in Quebec.

Every life insurer authorized in Canada must belong to Assuris. If a member insurer fails, Assuris protects a whole life policyholder for up to $1,000,000 or 90% of the promised death benefit, whichever is higher, and up to $100,000 or 90% of the promised cash value, whichever is higher, calculated on the net values after policy loans. A large corporate policy can exceed those amounts.

Dividends are not guaranteed. The insurer's board declares them based on the experience of the participating account, and past dividends do not predict future ones. A corporate projection built on a dividend scale is built on an assumption, so read the guaranteed column and the illustrated column as two different documents.

What should you ask, and of whom, in writing?

Of your accountant:

1. Does the proposed owner, payer and beneficiary arrangement raise a shareholder benefit question?
2. What is the corporation's adjusted aggregate investment income, with its associated corporations, and where does it stand against $50,000?
3. Do the Quebec paid-hours condition or the personal services business rules already limit the small business deduction?
4. How would a policy loan, a partial surrender or a surrender affect that measure in the year it happens?
5. How would the capital dividend account credit be calculated on the expected death benefit and the projected adjusted cost basis?
6. How would the policy affect the share tests, a wind-up or a reorganisation?

Of the insurer, through the representative:

• The guaranteed cash surrender value beside the cumulative premiums, year by year.
• The loan provision: how the maximum is set, how the rate is set and changed, and what happens if the balance overtakes the value.
• The current adjusted cost basis and how it is projected.
• The premium options if a premium cannot be paid.

And of whoever proposes the policy: how are you paid if I buy it, and what would you be paid if I did nothing? Several of the questions above earn nobody a commission, which is worth keeping in mind when you notice the order in which they come up.

Where does the rest of this sit?

Everything here is written by someone paid a commission by an insurer when a contract is issued, as stated at the foot of every page on this site. Services come only from Canadian Wealth Creation Centre Inc.; IBC Financial is its educational website. The wider corporate framework is under business owners, and how the contract itself works is under how a participating policy works. Now you decide.