The Real Estate Services Act and its accompanying regulations (collectively, "RESA") will come into force on January 1, 2022. One of the many changes brought about by RESA is the ability to perform real estate services through a personal real estate corporation.
With the new legislation allowing for the formation of Personal Real Estate Corporations ("PRECs"), an important decision for real estate registrants operating in Manitoba is determining whether or not to incorporate, and how to structure it. This decision can affect the amount of paperwork registrants must complete and how much tax they must pay on an annual basis.
It is not necessary for a real estate registrant to incorporate. Registrants under RESA can operate as individuals licensed under RESA or work for an already existing entity. However, depending on the activities and nature of the registrant, PRECs may provide a number of benefits as outlined below.
Why Incorporate? Is Incorporation Right for You?
One of the questions that will arise after January 1, 2022 is: "should I incorporate?" The answer to this question usually depends on a real estate registrant's particular situation and their particular needs.
Real estate registrants, namely each broker, associate broker, manager, supervisor, representative and salesperson (all more particularly defined within RESA) will soon have the ability to provide their services through a corporation. A corporation can be a very valuable and efficient tool in terms of tax and estate planning.
One benefit of incorporating is that it creates a separate legal entity distinct from the registrant. As a separate legal entity, the corporation pays corporate income tax, which is calculated separately from (and is usually lower than) the owner's personal income tax. Corporations can enter into contracts, own property and commence legal action in their own name. Further, the corporation will continue to exist regardless of changes in its ownership, although this is subject to certain ownership rules set out in RESA.
Limited liability protection for the corporation's shareholders is another benefit of incorporation. This means that the shareholders of the corporation cannot be held responsible for repaying any debts the corporation may incur beyond what they initially paid for their shares. However, real estate registrants are still fully personally liable for their professional obligations.
On the other hand, incorporation creates administrative responsibilities that do not exist for an unincorporated registrant. Such responsibilities include keeping a company registry, preparing corporate financial statements and filing corporate tax returns.
A corporation must satisfy all of the following conditions to be registered as a PREC:
- the corporation is incorporated, formed by amalgamation or continued under The Corporations Act (Manitoba) and is in good standing under that Act;
- the name of the corporation consists of the name of its controlling individual, or a recognizable short form of that name, followed by the words "personal real estate corporation";
- all voting shares are legally and beneficially owned by the corporation's controlling individual;
- each other share in the capital stock of the corporation is
legally and beneficially owned by
- the corporation's controlling individual,
- a spouse, common-law partner or child of the controlling individual, within the meaning of the Income Tax Act (Canada), or
- a corporation, each share of the capital stock of which is legally and beneficially owned by a person referred to in the above two points;
- the corporation's controlling individual is the president of the corporation and its only director;
- the corporation's controlling individual is registered under RESA, or is being registered at the same time as the corporation;
- the brokerage by which the corporation's controlling individual is engaged, or on whose behalf they intend to provide real estate services, consents to the application; and
- the PREC must be registered in the same RESA registration category, or categories, as its controlling individual.
Benefits of Incorporating
Providing real estate services through a corporation has several benefits:
(1) Tax Deferral and Small Business Deduction
The tax rate applicable to this type of income earned by a corporation is often lower than the rate that would apply to an individual that earned the income personally. This is particularly true where the corporation is eligible for the small business deduction, as the applicable corporate tax rate would be only 9% on the first $500,000 of active income, subject to certain limitations. PRECs give registrants the opportunity to leave a portion of their profits in their corporation. This allows registrants to defer the payment of personal taxes on such income until they withdraw money from the PREC. Unincorporated registrants are taxed on their profits in the year it is earned at their marginal tax rates and without any ability to defer taxes.
(2) Retirement Planning
In most circumstances, registrants can use the income tax deferral gained through the PREC to plan for retirement. Registrants can use excess funds in the corporation to purchase life insurance or investments, and they may achieve tax savings if they withdraw amounts from the corporation during retirement at a lower rate of taxation.
(3) Canada Pension Plan
In 2021, self-employed registrants with business income at or above $61,600 would have paid Canada Pension Plan contributions of just over $6,300. By transferring their business to a PREC and solely paying themselves dividends, they eliminate this annual cost. A PREC provides the flexibility to allow registrants to pay themselves by way of dividends or salary, depending on their specific needs at any given time. Owners can consider the comparative advantages of alternative compensation strategies.
(4) Income Splitting
In very specific circumstances, incorporating allows registrants to engage in income splitting with and between certain family members in lower tax brackets to reduce the family unit's overall tax burden. This is undertaken by issuing non-voting shares to the family members of a registrant. Income splitting allows corporations to split income among family members by paying them a reasonable salary for services rendered to the PREC or issuing dividends. Note however, that tax changes introduced by the Federal Government in July of 2017 restrict the ability to split income across family members unless they actively engage in the business on a regular and continuous basis. This applies to PRECs as well. In addition, registrants should note that any family members who work with the PREC must not perform services that require a real estate license.
Administration Costs and Requirements
With incorporation comes additional compliance requirements. For instance, record keeping and filing requirements are far more stringent for corporations. Furthermore, corporations must pay set-up costs and annual maintenance costs, leading to higher accounting fees. However, costs incurred while establishing a PREC are deductible expenses against income. Indirect taxes, such as payroll withholdings, goods and services tax, provincial sales tax and other provincial taxes on commissions earned, all add complexity.
Agreement Needed Between Individual Employee and Corporation
To enjoy the benefits of the PREC, the individual registrant who has set up the corporation must enter into a valid written agreement with the corporation. The registrant contracts to perform all of their real estate services as an employee of the PREC. The agreement must specify that the PREC will receive all revenues from the registrant's billings, including commissions, in respect of those services.
More Difficult to Use Losses
Registrants cannot apply personal income to business losses incurred through the PREC. Corporations can carry these losses three years backwards and up to 20 years forwards.
Primarily for High-Income Registrants
A PREC provides little tax advantage over an unincorporated individual if the registrant requires all earnings for personal use. That is, the primary advantage exists for registrants who can afford to leave some earnings in the corporation in order to reduce their personal income, and paying only the lower corporate tax rate.
Not a Shield to Professional Liability
Registrants should keep in mind that while incorporation offers several advantages, a personal services corporation does not shield an individual from errors and omissions liability (i.e. liability for negligence arising from providing services as a registrant). Even though registrants will provide services to clients through a PREC, the registrants will remain liable for their services and must meet all associated obligations and responsibilities. Accordingly, registrants must still obtain liability insurance following incorporation.
Choosing the right business structure is an important decision. There are advantages and disadvantages of functioning as an individual licensee or individually incorporating as a PREC. Real estate registrants should carefully consider and weigh these factors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.