A higher level of scrutiny will apply to individuals and sole proprietors who may be operating as a Personal Service Business.
As more Canadians choose to incorporate as individuals and sole proprietors, the Canada Revenue Agency (CRA) is engaging in an informational campaign to ensure these individuals, who may be operating as a Personal Service Business (PSB), sometimes known as an “incorporated employee,” understand their full tax obligation. Generally, a PSB exists where a person is incorporated and paid as a contractor but effectively operates as an employee. When a company is determined to be a PSB, different tax obligations apply. This article will explain what a PSB is, how a PSB is taxed differently than a small business and how to mitigate risk if you may be operating as an incorporated individual or sole proprietor.
What is a Personal Service Business and when do PSB tax obligations apply?
When a business hires a contractor with the requirement that the contractor incorporates, provides their services through that corporation and, if the corporation did not exist, they would be an employee, that corporation is considered to be a personal service business. In detail, the CRA may consider your corporation a PSB if:
- The incorporated individual performing services, or anyone related to them, is a specified shareholder of the corporation (A taxpayer who owns (directly or indirectly), at least 10% of the issued shares of any class of capital stock of the corporation)
- If the corporation did not exist, the incorporated employee would be considered an employee of the business receiving services
- The corporation does not employ more than five full time employees throughout the year
- The corporation’s income is from services performed by the incorporated individual
For examples of the difference between a PSB and a small business, please visit this CRA site
What are the differences in tax liabilities between a small business and a PSB?
If a corporation is determined to be a PSB, different tax rates and tax deductions apply. PSBs are not eligible for the small business or general tax rate reductions. Additionally, since the 2016 tax year, PSBs are subject to an additional tax of 5%, bringing their total federal corporate tax rate to 33%. PSBs are also subject to provincial/territorial corporate tax rates. For example, in Ontario, the combined rate is 44.5%, compared to 12.2% on income eligible for the small business rate.
PSBs are only eligible to only deduct:
- Salary and wages to its incorporated employee
- Any benefit or allowance provided to its incorporated employee
- Legal expenses the corporation incurs for collecting amounts owing
Mitigate PSB Risk
If the CRA may consider your corporation to operate as a PSB there are some steps you can take to mitigate your risk. Explicitly document the relationships with the business that contracts you. Consider paying a salary to the service provider instead of dividends as this is deductible for PSBs.
How Bateman MacKay can Help
The CRA is currently focussing on industries where it is a common practice to require individuals to incorporate to provide services like trucking, IT consultants, accountants, construction and catering. As a part of this campaign, CRA officials are asking businesses to provide documentation on the nature of their payer/payee relationships. Currently, this campaign is educational and encourages voluntary disclosure from individuals who may have been operating as a PSB and wish to amend prior tax returns. Moving forward, the CRA may target PSBs for audits and other scrutiny. If you have any questions about your tax requirements if operating as a PSB, please reach out to a Bateman MacKay Tax Advisor.
