Personal Services Business
Operating as a Personal Services Business (PSB) can have serious tax implications and increased scrutiny from the Canada Revenue Agency (CRA).
A PSB is a specific tax classification in Canada that applies to businesses where an individual provides services to another entity (usually a corporation) through their own corporation. First, let’s address the key characteristics of a PSB:
- Ownership: The services are provided by an incorporated individual or a corporation controlled by an individual.
- Client Relationship: The individual or corporation primarily provides services to one or a few clients.
- Work Integration: The individual providing services is integral to the business operations of the client.
If your business meets these criteria, it may be considered a PSB by the CRA. In this case, your business may be subject to higher corporate tax rates, and certain tax deductions and benefits available to regular corporations may not apply to your company.
The CRA has specific rules and guidelines to determine whether a business qualifies as a PSB. Being classified as a PSB is generally not favourable for tax purposes, so many individuals and corporations take steps to avoid this classification through restructuring their business arrangements.
Determining if your business is a PSB
Not sure if your business classifies as a PSB? If the following conditions are met, CRA will consider your business to be a PSB:
- As the incorporated employee who performs the services, you are a specified shareholder of the corporation – i.e., a taxpayer who owns, directly or indirectly at any time of the year, at least 10% of the issued shares of any class of capital stock of the corporation or a related corporation;
- If the corporation did not exist, you would be considered to be an employee of the company receiving the services;
- The corporation does not employ more than 5 full-time employees throughout the year; and
- The amounts received by your corporation for services were not received from an associated corporation.
Incorporated employee
The factors that help determine whether you are an incorporated employee are the same as those used in determining if an employee is employed or an independent contractor:
- The degree of control exercised by the payer over the service provider’s duties (i.e., more control may indicate an employment relationship)
- Whether the payer uses their own tools to perform the services (providing tools to a service provider suggests an employment relationship)
- Whether or not the service provider must carry out the work personally or if they can hire or subcontract the work (not being able to subcontract indicates an employment relationship)
- Whether or not the service provider has a capital investment in their business
- Whether the service provider has both a chance of profit and a risk of loss
- Providing similar services to other clients is an indicator of self-employment
The parties’ intent is also a factor. Was there a written contract for services outlining a business relationship and not employment? The existence of such a contract may not help, however, if the above factors point to an employment relationship.
Taxation of a PSB
As mentioned, PSBs are taxed differently, and generally not favourable. The income tax risks associated with being a PSB rest mainly with the service provider. There are 2 significant implications for tax purposes:
- A punitive corporate tax rate applies to PSB income; and
- There is a significant limitation on the corporation’s expense deductions.
Income of a corporation that is determined to be generated by a PSB is not eligible for the small business deduction and an additional 5% applies to that income. In Ontario, for example, the tax rate on PSB income is 44.5%, while the rate for income eligible for the small business deduction is 12.2%.
If the corporation is determined to be a PSB, then the deductions it can claim are also limited to the following:
- Salaries and wages paid to the incorporated employee;
- Employment benefits for that individual;
- Expenses of the corporation associated with selling property or negotiating contracts; and
- Legal expenses incurred by the corporation in collecting amounts owing.
All other expenses are not allowed, even if they were paid to earn income.
How to manage PSB risk
Managing the risk associated with a PSB in Canada requires a multifaceted approach. To mitigate the potential tax consequences and CRA scrutiny, individuals and corporations must carefully structure their business relationships to avoid falling into the PSB category. This includes diversifying client bases, ensuring that the services provided are not overly integrated with a single client’s operations, and documenting the independence of the business.
Additionally, seeking professional tax advice and staying informed about changing tax regulations is crucial for effective risk management. By proactively addressing these concerns and adhering to CRA guidelines, businesses can reduce the inherent risks associated with PSB classification and ensure their tax compliance remains on solid footing. Here are some suggestions to help you manage this PSB risk:
- Pay out corporate earnings as salary
This will reduce the amount of corporate income that could be taxed at the PSB rate. Salaries paid qualify as a deduction, however, any accrued bonuses are deductible only when paid. - Document the relationship
Clearly document the relationship in a written agreement that states the parties have not agreed to an employment relationship. CRA could, however, still review or audit the corporation, even with such an agreement in place. - Obtain a ruling from CRA
This provides greater certainty as to whether a service provider is employed or self-employed. There is still the risk, however, that CRA may determine that an employee relationship exists, therefore, if the service provider is clearly not an incorporated employee, it may be best not to request such a ruling so as not to highlight this arrangement.
The CRA recently conducted an educational outreach project to help industries that hire PSBs understand and comply with their tax obligations associated with this type of arrangement. The results of this project are in the process of being compiled. CRA has noted that there will be “additional phases to this pilot”.
Still unsure if the PSB rules apply to you? Please contact Lott & Company. We are happy to help you navigate these waters and make the best decisions with you in mind.
