Starting your own practice? Picking the right legal structure (Part 5)

Apr 01

Starting your own practice? Picking the right legal structure (Part 5)

Business Law, Sole Practitioner Add comments

Please keep in mind that this is not legal advice. The information provided herein is for educational purposes only. If you believe you require assistance in deciding which business structure is best for you, then you are encouraged to seek a professional (e.g. make a post on Dynamic Lawyers).

In this blog, I’ll be discussing professional corporations.

Some of the biggest advantages to operating a law firm through a professional corporation include:

Tax benefits and tax deferral through the small business credit and the lifetime capital gains exemption to qualifying small businesses;
The ability to raise capital through a security issuance (e.g. equity or debt);
The prestige factor that goes along with having a “Professional Corporation”; and
A lawyer can choose his or her salary and dividend mix in order to minimize tax exposure.

The disadvantages to operating a law firm through a professional corporation include:

Unlimited liability for the corporate shareholders;
Inability to engage in income splitting via share ownership;
Relatively high start-up costs and ongoing maintenance costs (e.g. accounting, meetings and minutes, payroll, and taxes); and
Creating and maintaining a separate bank account, letterhead, business and tax numbers, etc.

Definition
Ontario’s Business Corporations Act “["BCA"]and the Law Society of Upper Canada’s By-Law #7 govern professional corporations. In the legal context, a professional corporation is a corporation whose shareholders (s. 3.2(1)(1) of the BCA), officers and directors (s. 3.2(2)(2) of the BCA), and managers (s. 32 of By-Law #7) are licensed members of the Law Society of Upper Canada.

Ease of Creation
By and far, a professional corporation is the most onerous – in terms of cost, time, and effort – to create. Ontario’s Business Names Act provides that “[n]o corporation shall carry on business or identify itself to the public under a name other than its corporate name unless the name is registered by that corporation”(s. 2(1) of the Business Names Act).

A professional corporation must first be incorporated in Ontario. Furthermore, lawyers may not practice law through a professional corporation until they have received their Certificate of Authorization from the Law Society – which entails completing an application form and paying an additional fee.

Continuity
Among other things, so long as the directors/officers of the corporation file the company’s annual return and the company is not cancelled for failing to comply with tax requirements, the company will survive the death or bankruptcy of its shareholders and managers and its shares may be perpetually transferred.

Liability
Section 3.4(1) of the Business Corporations Act provides that the professional liability of a shareholder of a professional corporation is unlimited under an Act governing the profession for acts of the shareholders or acts of employees or agents of the corporation. Importantly, this means that, unlike with typical corporations, shareholders of professional corporations are not immune from unlimited personal liability.

Security Interests

Only individuals who are licensed by the Law Society of Upper Canada to provide legal services to the public pursuant to a Certificate of Authorization can be shareholders of a professional corporation (Business Names Act, s. 3.2(2)1). As a separate legal entity, a professional corporation is capable of owning security interests in other business entities and properties.

Taxation
A professional corporation may have the best or worst tax treatment of all the business organizations examined (depending on whether net income is reduced down to zero via labour/employment expenses). On the one hand, if the shareholder lawyers are making more money than they need to be comfortable, then they might consider incorporating and paying themselves a salary less than what the corporation earns so as to defer taxes. On the other hand, the corporation is the only form of business organization whose income is double taxed: the professional corporation’s income is taxed and then whatever retained earnings are distributed to the shareholders are taxed again. As discussing the taxation of corporations is long and complicated, I won’t be getting into it here.

If you have comments, questions or concerns about taxation or other issues involving professional corporations,you’re encouraged to go to Dynamic Lawyers and make a post to get free information and quotes from local lawyers.