This article originally appeared on the MNP website. Image credit: The Images of Pharmacy Practice Project | EPICORE Centre & Jim Dobie Photography
by Jim Chagnon, CPA, CA, TEP, Partner, Private Enterprise Professionals
In this three-part series, we’ll explore what it takes to become a pharmacy business owner, how plans and needs change over time, and navigating through each stage with confidence.
Deciding whether to incorporate or not to incorporate is one of the most common dilemmas facing pharmacists in their professional lifecycle. Part One and Part Two of this series examined business plans and need-to-knows about buying a pharmacy. Before delving into the pros and cons of incorporating, let’s go over some key considerations when choosing how to structure your business. Working with a trusted lawyer and accountant will help.
Understanding the basics
Tax rates and regulations vary from province to province, no matter the structure. Since no two businesses are the same, it is important to evaluate which structure best fits your situation and goals. The following are three basic ways to structure your business.
Sole proprietorship - As a sole proprietor of a business, the income from the business and the taxes on that income are considered yours and charged at personal income tax rates and summarized on your personal income tax return each year. Business losses can be written off against other income. Sole proprietorships are easy to set up and administer. A major consideration of this structure is the potential for exposure not to only professional liability, but commercial and personal injury claims as well.
Partnership - A partnership acts similar to a proprietorship, but with more than one individual involved. A proportionate share of the business income is allocated to each partner to be included in their incomes for personal tax purposes. Also, business losses can be written off against other income of the partners on their personal returns. As with a sole proprietorship, all partners are jointly liable for all debts.
Corporation - A corporation is a legal entity entirely separate from you, the business owner. Profits, taxes, and tax returns are all calculated separately from you, the individual, at lower corporate tax rates. A corporation is subject to federal, provincial and territorial regulations, has more complex administration, and is more costly to set up and maintain.
Things to consider
If you are starting out small, as a single investor with no partners, you might consider a sole proprietorship. As your business evolves, and your planning objectives change, you might want to revise your business structure to provide greater benefits. There are more complex structures and options available as the business matures.
Risk management, income tax and regulatory issues jump out when weighing the pros and cons of incorporating.
Risk management - A corporation offers a number of ways to mitigate risk through your business, the foremost being reduced personal liability: your personal assets are protected from creditors and other claimants should the business be unable to meet its obligations. Note there continue to be professional liability exposures.
If you acquire real estate through a corporation, for example the building the pharmacy is operating in, you remove yourself as the individual from tenant / personal injury liability. Consideration will need to be given to whether one or multiple corporations are used if acquiring multiple locations. Under a single corporation, risks are shared among the locations, whereas separate corporations can isolate those risks. The use of multiple lenders may also require separate corporations in order to address security requirements of those lenders against appropriate business assets.
Income tax – Being incorporated provides substantial tax advantages, including:
- Tax deferrals: Corporate tax rates can be up to 40 percent less than personal tax rates on the first $500,000 of taxable income annually, which can represent up to $200,000 a year in tax deferrals. As owner, you can use those tax savings to retire debt faster, acquire more stores, make improvements, or invest surplus funds and build wealth faster.
- Compensation planning and income splitting: With appropriate regard for both regulatory and taxation rules, it is possible to introduce family members with lower income who are active in the business, such as a spouse or adult children, as shareholders of a corporation in order to benefit from tax savings.
- Family trusts (often with a holding company): Family trusts are effective in succession planning, protecting assets, and multiplying the benefits of lifetime capital gains exemptions.
- Capital gains exemption: Eligible taxpayers may claim a lifetime capital gains exemption of $892,218 in 2021 (tax savings of up to $239,000 per taxpayer). As noted above, an incorporated business can be structured to multiply the capital gains deduction via direct shareholdings or trust interests with their spouse or adult children. The business must be a qualified small business corporation to be eligible for this deduction.
- Dividends and / or salary: You have a lot of flexibility as an active employee and corporate shareholder in claiming income, through dividends and / or salary, enabling personal income smoothing, and ease in budgeting and cash flow management.
- Financing: The use of a corporate structure provides more after-tax funds to repay debt and facilitates interest deductibility.
- Growth: Should the corporation acquire multiple pharmacies in future, you will be able to offset losses against profits where a single corporation is used.
Regulatory – There is no doubt the pharmacy regulatory requirements of corporations are complex, are different across provincial jurisdictions, and can be costly to set up for continued compliance, including share ownership requirements. It is critical to structure your corporation properly to balance the cost / benefit ratio and obtain maximum benefit for the circumstances. Work with an experienced team (lawyer, accountant) that is knowledgeable in building corporate structures to ensure it works for you and the regulators.
Most Common Pitfalls
One of the biggest errors people make when starting out as business owners is not putting enough time into planning the right structure. Know what you want to achieve, who you want to achieve it with, and consult with advisors on the how.
Don’t be fooled into handling an incorporation on your own. Whatever size business, you’ll need to draw on the experience and expertise of advisors to make sure incorporating is the best fit for you now, is flexible for the future and you are compliant with all regulations now and in future.
The road to pharmacy ownership can be challenging, but with proper planning and the right team working alongside you, the journey can be a successful one.
Contact
For more information, contact Jim Chagnon, CPA, CA, TEP, at 289.293.2311 or jim.chagnon@mnp.ca