As a pharmacy owner, how you setup your corporation will determine how much tax you will pay in the future when you sell your pharmacy.

Do you want to pay more in tax than you should?

That's right: no one does!

Unfortunately, many pharmacy owners take shortcuts when initially setting up their pharmacy corporation, leading to mistakes.

I don't blame you. Starting out, cash flow is super tight, so you want to save as much in costs as possible. That's why many owners incorporate themselves online.

But there are several tax planning strategies available that many of you don't know about until you seek out advice.

And by that time, while it's not too late to fix mistakes, it will unfortunately cost more in lawyer and college fees than what you originally spent the first time around. 

But if you fix these mistakes sooner rather than later, the thousands of dollars is tax that you will save in the future will far outweigh this cost. 

How much savings? $232,028. 

Here's what the common mistake is and how to fix it.

When we talk about corporate structure, we refer to the setup and share structure of your pharmacy corporation.

 There are two ways to setup your pharmacy corporation:

1. Health professional corporation
2. Ontario Corporation

Each type has different rules as to who can be shareholders. Regardless of which option you choose, you can have different classes of shares, with the following attributes:

• Growth shares (those who share in the growth of your pharmacy)
• Non-growth shares
• Voting (those who can make decisions affecting your pharmacy)
• Non-voting

Many pharmacy owners don't know these options because no one out there is educating pharmacists on these topics.

Only pharmacists can be shareholders of a health professional corporation. These are less flexible than an Ontario corporation and the College of Pharmacists in Ontario (OCP) does not force you to practice under a health professional corporation.

The tax planning strategies are limited, compared to an Ontario corporation.

Thanks to lobbying done by the OCP, you also have the option of operating under an Ontario corporation where you can add family members as shareholders.

However, at least 51% of the corporation must be owned and controlled by you (the pharmacist).

If you have a spouse, you can setup an Ontario corporation with:

• 51% growth, voting shares (you)
• 49% growth, non-voting shares (your spouse)

By adding your spouse or adult family member, s/he can claim the lifetime capital gains exemption in the future when you sell your pharmacy.

Why should you care? Because this is a tax planning strategy that will help you shelter thousands of dollars of tax in the future. Why pay the CRA more in tax when you don't have to?

Back in 1985, the Canadian federal government announced a tax change as an incentive for people to start their own business.

The lifetime capital gains exemption (LCGE for short) was created to tax shelter first $500,000 of growth (called a capital gain) of your small business corporation.

Business is great for our economy. The more businesses there are, more Canadians are employed, receive an income, and in turn buy things likes homes, cars, etc. to help our economy grow.  

Fast forward to 2019, the lifetime amount is now $866,912 and increases every year for inflation.

Time and again, we see pharmacy owners who don't add their spouses as shareholders to their pharmacy corporation.

That's because many just simply do not know that you can add family members as shareholders. 

So when incorporating yourself, your natural instinct is to setup your corporation with yourself as the sole 100% shareholder.

Because of the 2017 capital gains exemption, the first $835,714 is tax-free. Since your pharmacy sale is treated as a capital gain, only half of the remaining balance is taxable at your personal marginal tax rate.

Both Jessica and Alan are in the highest tax bracket, which in Ontario is about 53%.

What if Jessica had setup her pharmacy corporation with Alan as a 49% shareholder? The same situation in 2017 would have yielded completely different outcome.

See the difference? $221,464 in tax savings with the proper corporate structure.

Based on the 2019 capital gains exemption, these tax savings increases to $232,028!

While it's ideal to know and implement this tax planning technique BEFORE you incorporate, unfortunately it is often overlooked for many reasons:

• You didn't know; and
• You try to save costs by incorporating yourself; or
• You didn't get proper advice from your accountant or lawyer

Or maybe you DID know but are worried about risk for your spouse if you put him or her on as a shareholder?

Let's put it this way.

Many of you had to get a business loan to start or purchase your pharmacy and put your house as a personal guarantee for the loan. 

You and your spouse own the home, so already the two of you and your house are at risk if your pharmacy isn't successful.

So why not through him or her on as a shareholder to shelter tax in the future when you sell your pharmacy?

If you did NOT provide a personal guarantee, even better!

The beautiful thing about being a shareholder is limited liability. If the pharmacy isn't successful, your creditors can only go after the amount you and your spouse have invested in the corporation and NOTHING more. Again, this is IF you did not provide any personal guarantees as condition of your loan.

Don't throw away the opportunity to tax shelter as much as you can, especially $221,000.  

What if you already incorporated but didn't add your spouse as a shareholder, can you still add him or her?

If you are not planning to sell your pharmacy in the next 2 years, it’s not too late.

That’s because one of the rules to qualify for the capital gains exemption is that you must hold the shares for at least 2 years.

To add your spouse as a shareholder, this can be done via a tax planning strategy called an “Estate Freeze.”

To describe an estate freeze, in the most simplest terms, is that current value of your pharmacy is ‘frozen’ and locked in your name; any future growth in the value of your pharmacy is subject to this 51%/49% share split between you and your spouse.

The sooner you get an estate freeze done, the better.

​That's because, as time goes on, there is less time for your spouse to participate in the growth in value of your pharmacy; and that means less tax savings. 

But of course, there are accounting and legal costs in order to perform an estate freeze. Typically, this can cost anywhere between $3,000 to $5,000.

Your accountant will outline the strategy on how to perform an estate freeze and your lawyer will take care of the necessary changes to the articles of incorporation. 

As we saw in our example, this is well worth the cost in order to save $220,000+ in tax in the future.

When adding a spouse as a shareholder to your corporation, of course you need to think of nightmare scenarios like divorce and death.

That’s why a separation agreement is necessary.

By having a separation agreement, you ensure that your spouse is forced to sell you his shares at fair market value (FMV) and in a reasonable timeframe instead of holding back or trying to sell for a higher price. The cost for this type of agreement is typically about $1,000+HST from a lawyer.

With respect to death, a Secondary Will is necessary.

A corporation is a separate legal entity and is not covered by a Primary Will, which only covers assets in personal name. Many pharmacy owners do not know this.

If you add your spouse as a shareholder, each of you will need a Secondary Will, which will dictate what happens to you and your spouses’ shares at death.

Even if you don’t add your spouse as a shareholder, you should have a Secondary Will so that, at death, your pharmacy is disposed of as per your wishes, not the courts.

Protect yourself no matter the situation that arises.

Are you planning to get married at some point in the future?

If the answer is yes, then setup an Ontario corporation, that way you have the flexibility to add your spouse as a shareholder in the future via an estate freeze.

If the answer is no, then consider adding parents or children (mentioned below).

At the very least, ensure that you have a Secondary Will so that, at death, your pharmacy is disposed of as per your wishes, not the courts.

Typically, pharmacy partners setup their corporation as 50/50 partners, so there would be no room to add spouses on as growth shareholders.

However, you still have the option of adding each of your spouses as non-growth, non-voting shareholders.

Why would anyone do this? To income split with your spouses if s/he is in a lower tax bracket via dividends.

But with income splitting rules changing, this tax planning strategy may no longer be valid. Extra consideration to this topic is warranted for 2018 and future years.

And that’s fine because you and your partner(s) will still each be able to use your lifetime capital gains exemption, tax sheltering $1.67M (or more with additional partners) of capital gains.

A partnership agreement is necessary when operating with a partner(s).

This agreement outlines how disputes will be resolved and ensures that at death of each partner, the other partner(s) has/have the first right to acquire the deceased partner’s share. Or in the case of simultaneous death of all partners, the agreement will dictate what happens to your pharmacy if this happens.

Yes, for Ontario corporations but no for the health professional corporation.

Generally, parents are not added as growth shareholders because most of the time your parents pass away before you sell your pharmacy.

Having your parents on as growth shareholders would require pharmacy valuations done at time of each of their deaths and you will have to come up with the money to pay the value of their shares. And most likely, you want that money to come back to you but if you have siblings, that might not always be the case.

Thus, many pharmacy owners do no elect to go this path because of the added complexities.

However, you still have the option of adding each of your parents as non-growth, non-voting shareholders.

Again, - why would anyone do this? To income split via dividends with your parents if they are in a lower tax bracket.

But with income splitting rules changing, this tax planning strategy may no longer be valid. Extra consideration to this topic is warranted for 2018 and future years.

Yes, for Ontario corporations but no for the health professional corporation and your children must be age of majority, which is 18 in Ontario.

Generally, children are not added as growth shareholders because by the time they reach age of majority, your pharmacy value has already reached a high point.

An alternative is to setup a trust with children as beneficiaries to successfully multiply the capital gains exemption.

This year, however, the Government attacked this tax planning technique using trusts, but their proposal did not go through.

You still have the option of adding your children as non-growth, non-voting shareholders.

Again - why would anyone do this? To income split via dividends with your children because they are in a lower tax bracket.

But with income splitting rules changing, this tax planning strategy may no longer be valid. Extra consideration to this topic is warranted for 2018 and future years.

When starting out, cash flow is tight, so often you are more inclined to get incorporated online to cut costs. And once things start going well, you plan to seek professional advice.

Then, pharmacy owners realize that their corporate structure needs to be changed to take advantage of tax planning opportunities.

One of these changes is to add a spouse or adult family member as a shareholder to your pharmacy corporation to multiply the lifetime capital gains exemption.

The lifetime capital gain exemption allows you to tax shelter $835,714 (as of 2017) of growth in the value of your pharmacy. By adding additional growth shareholders, each can claim the LCGE.

By adding your spouse as a growth shareholder will help shelter approximately $220,000 in tax in the future when you sell.

If you have already setup your corporation but want to add a family member on as a shareholder, then it’s not too late to add them.

This can be done through an estate freeze.

While there are costs to do an estate freeze, the tax savings will significantly outweigh the costs.

Your accountant will outline the strategy on how to perform an estate freeze and your lawyer will take care of the necessary changes to the articles of incorporation. 

And the earlier you get an estate freeze done, the less you will pay in tax in the future when it’s time to sell your pharmacy.

You have spent years increasing the value of your pharmacy! Don’t let money go to tax if it doesn’t need do.