2005 Ruling 2004-0093711R3 - Incorporating a Proprietorship

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a physician who is also a faculty member of a university can conduct a medical practice through a corporation. Whether such corporation would be personal services business.

Position: Yes. and No.

Reasons: The physician's employment contract permits the physician to carry on a medical practice in such a manner, as does the applicable provincial legislation. The practice carried on by the corporation would not be a personal services business.

XXXXXXXXXX 2004-009371

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above. We acknowledge receipt of the additional information in your XXXXXXXXXX letters and in our various telephone conversations (XXXXXXXXXX).

We understand that, to the best of your knowledge, none of the issues involved in the ruling request:

(i) is in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person,

(iii) is under objection or appeal by the taxpayer or a related person,

(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired, and

(v) is the subject of a ruling previously issued by the Canada Revenue Agency.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supplement), c.1, as amended, (the "Act") and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

Definitions

(a) "CRA" is the Canada Revenue Agency;

(b) "Province" is the Province of XXXXXXXXXX;

(c) "Employer" is the XXXXXXXXXX;

(d) "College" means the XXXXXXXXXX;

(e) "Professional" is XXXXXXXXXX;

(f) "Association" is the XXXXXXXXXX, which represents and acts on behalf of faculty members of the Employer;

(g) XXXXXXXXXX negotiated between the Employer and the Association;

(h) "BCA" is The Business Corporations Act of the Province;

(i) "Newco" is a new company to be incorporated pursuant to the BCA of the Province;

(j) "Health Authority" is the XXXXXXXXXX;

(k) "XXXXXXXXXX Services Contract" is the XXXXXXXXXX contract between the Professional and the Health Authority pursuant to which the Professional agrees to provide XXXXXXXXXX services to the Health Authority;

(l) "XXXXXXXXXX Services Contract" is the XXXXXXXXXX contract between the Professional and the Health Authority pursuant to which the Professional agrees to provide XXXXXXXXXX services to the Health Authority;

(m) "XXXXXXXXXX Agreement" is the existing agreement between the Employer and the Professional which agreement provides the existing basis for payment to the Professional of amounts received by the Employer for services provided by the Professional pursuant to the XXXXXXXXXX Services Contract and the XXXXXXXXXX Services Contract;

(n) "XXXXXXXXXX Agreement" is the agreement to be entered into by the Professional and the Employer as the replacement for the XXXXXXXXXX Agreement;

(o) "Facilities" means the College of Medicine at the Employer's premises and the hospitals operated by the Health Authority;

(p) "Practice" means the Professional's provision of all clinical/medical services currently provided to the Employer and the Health Authority;

(q) "Legislation" is the Province's XXXXXXXXXX;

(q) "Canadian-controlled private corporation" ("CCPC") has the meaning assigned by subsection 125(7) of the Act;

(r) "Cost amount" has the meaning assigned by subsection 248(1) of the Act;

(s) "Eligible Property" has the meaning assigned by subsection 85(1.1) of the Act;

(t) "Personal services business" has the meaning assigned by subsection 125(7) of the Act;

(u) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(v) "Taxable Canadian corporation" ("TCC") has the meaning assigned by subsection 89(1) of the Act.

Facts

1. The Employer is a university located in XXXXXXXXXX, which offers inter alia, degrees for post-secondary education, medical residents and graduate studies through the College and also carries on research through the College. The Employer's Business Number is XXXXXXXXXX and the Employer deals with the XXXXXXXXXX Tax Services Office.

2. The Professional is a member of the College and is currently employed as a faculty member by the Employer. The Professional's duties are comprised of teaching (including clinical instruction) and performing research. The Professional practices medicine as a XXXXXXXXXX and XXXXXXXXXX. The Professional's social insurance number is XXXXXXXXXX, files income tax returns with the XXXXXXXXXX Taxation Center and deals with the XXXXXXXXXX Tax Services Office.

3. The teaching or scholarly relationship between the Employer and the Professional is dictated by the XXXXXXXXXX. The XXXXXXXXXX recognizes that the relationship between the Employer and the Professional is unique. In particular, Article XXXXXXXXXX of the XXXXXXXXXX sets forth general rules applicable to faculty members that wish to carry on consulting or clinical work. Such work is permitted provided that it does not affect the Professional's ability to fulfill their employment duties. In addition, Article XXXXXXXXXX of the XXXXXXXXXX provides the approval mechanism for such outside work, and Article XXXXXXXXXX of the XXXXXXXXXX recognizes that certain earnings and fees received by XXXXXXXXXX that are a member of the College, and that arise from clinical duties, are not subject to the XXXXXXXXXX.

4. The Professional currently carries on the practice of medicine pursuant to the XXXXXXXXXX Services Contract and the XXXXXXXXXX Services Contract. These contracts are contracts for services entered into by the Health Authority and the Professional. The Employer is not a party to these contracts. The Professional does not see, diagnose or treat patients at the Employer's place of employment. The Professional carries out patient care at hospitals that are not owned or operated by the Employer.

5. The contractual relationship that is established for medical care is between the Professional and the patient. The Employer and the Province's Department of XXXXXXXXXX are not parties to this agreement, although the Province's Department of XXXXXXXXXX agrees to pay for such services. As such, if there is non-performance or negligence by the Professional, it is typically the Professional that is sued, not the Employer.

6. Revenue for clinical services provided by the Professional are paid through the Employer in a number of ways, including:

(a) Fee For Services Basis - the Province's Department of XXXXXXXXXX has established a fee schedule which compensates a physician based upon the service provided and having regard to their area of practice and specialty. When a physician tends to a patient, the physician records the details of such visit or attendance and the nature of the services provided. The physician is then entitled to submit an invoice or request for payment for such services through the Province's Department of XXXXXXXXXX and to be paid pursuant to the Province's XXXXXXXXXX. These billings and payments will occur in the same manner as that of any other physician that renders fees for services performed within the Province;

(b) Alternative Payment Basis - the Province, through its Department of XXXXXXXXXX and the Health Authority, may enter into an agreement with the Professional which agreement will provide that a physician or group of physicians shall provide services in respect of a particular specialty. The agreement does not provide any specific rules as to the number of patients that must be attended to or the times at which such services must be provided, but rather ensures that there will be physicians of the particular specialty available to provide such services when required.

7. All revenue currently earned by the Professional under the XXXXXXXXXX Services Contract and XXXXXXXXXX Services Contract are paid to the Employer pursuant to the terms of the XXXXXXXXXX Agreement. The XXXXXXXXXX Agreement also provides the basis for payments from the Employer to the Professional in respect of such amounts received by the Employer. The payments to the Professional pursuant to the XXXXXXXXXX Agreement have been included in the Professional's income for income tax purposes.

8. Students, medical residents and graduate students from the College will often accompany the Professional when the Professional is meeting with, diagnosing and/or treating patients. The students, medical residents or graduate students will be present to observe and/or participate in the patient treatment process to facilitate training.

9. The Employer and the Health Authority have entered into two agreements, the "XXXXXXXXXX Agreement" and the "XXXXXXXXXX Agreement", to govern the relationship between the Health Authority and the College as it relates to the efficient operation of the Facilities. The XXXXXXXXXX Agreement sets forth the relationship between the Employer and the Health Authority as it relates to faculty and students from the College and from the other Colleges involved in, or related to, the health care field (i.e. XXXXXXXXXX). As an adjunct to the XXXXXXXXXX Agreement, the Employer and the Health Authority are subject to the XXXXXXXXXX Agreement, which specifically governs the relationship between the Employer, faculty and students from the College and the Health Authority.

10. XXXXXXXXXX.

Proposed Transactions

11. The University desires to change its relationship with the Professional in order to facilitate either the incorporation of the Professional's Practice or to allow the Professional to carry on the Practice as a sole proprietor. Similar to the objectives of the Province, the Employer anticipates that this change will enhance retention and future recruitment of physicians within the College.

12. The Employer and the Professional will enter into the XXXXXXXXXX Agreement, which will provide, among other things, the following:

(a) Pursuant to XXXXXXXXXX, the Professional may carry on the Practice in any manner provided the Professional complies with the terms of the XXXXXXXXXX Agreement;

(b) The Professional shall ensure that the Practice will not in any way prevent the Professional from performing the academic responsibilities assigned by the Employer;

(c) The Professional shall agree in writing, pursuant to an "XXXXXXXXXX Agreement", to appoint the Employer as his agent to perform certain administrative services, including the billing and the collecting of the revenue earned by the Professional in the Practice;

(d) The Professional shall agree to pay the Employer a XXXXXXXXXX fee, in recognition of the various other costs incurred by the Employer and from which the Professional benefits. By paying this amount, the Professional will be allowed to go out and earn income from the medical business; and

(e) The Professional shall be entitled to assign his rights under the XXXXXXXXXX Agreement, but notwithstanding any such assignment of all or a portion of the rights and obligations there under, the Professional shall remain liable for any non-performance or breaches of the XXXXXXXXXX Agreement.

13. Upon execution of the XXXXXXXXXX Agreement and the XXXXXXXXXX Agreement, the XXXXXXXXXX Agreement will cease to have effect.

14. The terms and conditions outlined under the XXXXXXXXXX will continue to apply to the Professional and the Employer in regards to the Professional's teaching and research responsibilities.

15. The Professional will incorporate Newco pursuant to the Province's BCA. The share capital of Newco will include the following:

(a) The Class "A" Common Non-Voting Shares will be shares that will be entitled to participate in the earnings of Newco and to receive pro-rata dividends when and if declared by the directors of Newco. Upon windup, these shares shall, subject to priority for the redemption of any of the Class "C" Preferred Shares that have been issued, be entitled to share, on a pro-rata basis with the Class "B" Common Voting Shares, in the remaining assets of Newco;

(b) The Class "B" Common Voting Shares will be entitled to vote, participate in the earnings of Newco and to receive pro-rata dividends, when and if declared by the directors of Newco. Upon wind-up, these shares shall, subject to priority for the redemption of any of the Class "C" Preferred Shares that have been issued, be entitled to share, on a pro-rata basis with the Class "A" Common Non-Voting Shares, in the remaining assets of Newco;

(c) The Class "C" Preferred Shares will be non-voting shares that will be redeemable at the option of Newco or the holder. These shares will not be entitled to participate in the earnings of Newco and will generally not be entitled to receive dividends in respect of the earnings of Newco. From time to time, at the sole discretion of the directors of Newco, the shareholders of the Class "C" Preferred Shares may be entitled to receive dividends.

16. The Professional will subscribe for and be issued Class "B" Common Voting Shares of Newco. The Legislation permits members of the Professional's family to own non-voting shares of Newco. It is our understanding that none of these non-voting shares will be issued as part of the proposed transactions described herein.

17. All rights of the Professional to provide clinical medical services to patients or other physicians, and all property owned by the Professional which is required or used by the Professional in carrying out the Practice (hereinafter referred to as the "Transferred Assets") will be transferred to Newco under the terms of a written agreement to be entered into between the Professional and Newco (the "Transfer Agreement"). The Transferred Assets will include the assignment to Newco of all of the Professional's rights and obligations under the XXXXXXXXXX Services Agreement and XXXXXXXXXX Services Agreement, as approved by the Health Authority. The XXXXXXXXXX Services Agreement and XXXXXXXXXX Services Agreement will be amended, as required, to reflect the proposed assignment.

18. The Transfer Agreement will provide that the Transferred Assets are to be transferred to Newco at a sale price equal to their fair market value. In exchange, Newco will issue the Professional a sufficient number of Class "C" Preferred Shares, which shall have an aggregate redemption value equal to the fair market value of the Transferred Assets. The Transfer Agreement will include a price adjustment clause to adjust the number of shares issued to the Professional if it is subsequently determined that the value of the shares issued was not equal to the fair market value of the Transferred Assets. Newco and the Professional will jointly elect, pursuant to subsection 85(1) of the Act, in prescribed form and within the time permitted by subsection 85(6) of the Act, to have the provisions of paragraphs 85(1)(a) to (i) of the Act apply. The "agreed amount" for the assets transferred to Newco will not be less than the lesser of the amounts specified in subparagraphs 85(1)(c.1)(i) and (ii) of the Act, will not be less than the least of the amounts specified in subparagraphs 85(1)(d)(i), (ii) and (iii) of the Act, and will not be less than the least of the amounts specified in subparagraphs 85(1)(e)(i), (ii) and (iii) of the Act. Furthermore, the "agreed amount" will not exceed the respective fair market value of each asset transferred to Newco nor will it be less than the amount permitted by paragraph 85(1)(b) of the Act.

19. Newco and the Professional will enter into an employment agreement that will provide that the Professional will carry on the Practice as an employee of Newco. The employment agreement will also provide that Newco is entitled to any and all billings and revenues paid/payable in respect of the Practice.

20. The Professional will assign the rights and obligations of the Professional, pursuant to the XXXXXXXXXX Agreement, to Newco. Newco will also agree to be bound by the terms of the XXXXXXXXXX Agreement as it relates to provision of certain administrative services by the Employer, and in particular, the method of billing on a fee for service basis in respect of the attendance by the Professional upon patients on behalf of Newco. The Employer will pay Newco, on a monthly basis, the revenues collected on behalf of the Professional minus the amounts payable pursuant to the XXXXXXXXXX Agreement. This amount will be defined in the XXXXXXXXXX Agreement as the Net Medical Revenue.

21. Initially, the Professional will be the sole employee of Newco. Support staff and administrative staff may be hired if there is sufficient need. However, since many of the administrative services will be provided by the Employer pursuant to the XXXXXXXXXX Agreement, it is expected that Newco will have fewer than 6 full time employees at any particular time. The Professional will be the sole director of Newco and will be the sole voting shareholder of Newco.

22. Newco will have sole responsibility for, or benefit from, the related revenues and expenses from carrying on the Practice through Newco. For example, bad debts or uncollectible amounts will be the responsibility of Newco, not the responsibility of the Professional or the Employer. Notwithstanding the above, the Legislation provides that the Professional will remain personally liable for any negligent acts performed by the Professional in the course of carrying on the Practice through Newco.

Purpose of the Proposed Transactions

23. The purpose of the proposed transactions, from the perspective of the Employer, is to allow faculty members who are physicians to carry on their medical practices independent from the Employer, either through a corporation or as a sole proprietor. This change is intended to enhance the Employer's ability to retain and recruit physicians within the College. From the perspective of the Professional, the proposed transactions will allow the Professional to carry on the business of providing medical services to patients through a corporation.

Rulings

Provided that:

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions;

(b) the proposed transactions are completed in the manner described above; and

(c) there are no other transactions which may be relevant to the rulings requested;

our rulings are as follows:

A. The clinical medical services provided by Newco through its employee, the Professional, will constitute a business carried on by Newco in accordance with the definition of business in subsection 248(1) of the Act.

B. The business activities of Newco will not be considered a personal services business, as defined in subsection 125(7) of the Act.

C. The Net Medical Revenue (as defined in paragraph 20 above) to be paid by the Employer to Newco, pursuant to the XXXXXXXXXX Agreement, will not constitute employment income and therefore, the Employer will not be required to withhold income tax in respect of such payments pursuant to subsection 153(1) of the Act.

D. The business income of Newco will not be included in the Professional's income by virtue of subsections 56(2) and 56(4) of the Act.

E. Subsection 245(2) of the Act will not be applied to re-determine the tax consequences of the rulings given above.

Comments

The attribution rules in sections 74.1 to 74.4 of the Act apply in situations where property is transferred or lent, directly or indirectly, to a spouse or child. These rules may apply to any income received by a spouse or a child who has not attained the age of 18 years before the end of a particular taxation year. Whether or not these rules will apply in respect of the ownership of any non-voting shares of Newco, as described in paragraph 16 above, is a question of fact that can only be determined at the time that the shares are issued or property is lent or transferred to such a shareholder. Furthermore, subsection 56(2) of the Act may apply to any amounts paid by Newco to a spouse or child of the Professional who owns the non-voting shares of Newco.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by the CRA on May 17, 2002, and are binding on the CRA provided that the proposed transactions are implemented on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Except as expressly stated, this advance income tax ruling does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions.

Yours truly,

XXXXXXXXXX
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch