Each year I help over 500 clients file their Canadian and US tax returns as well as plan for both their Canadian and US investment accounts. I also regularly help new US clients plan for their move to Canada.
If your corporation is deemed to be a personal services business (PSB) your corporation is no longer eligible for the small business deduction (SBD) and its income is taxed at full corporate tax rates. For 2016 the B.C. corporate tax rate on income eligible for the small business deduction is 13% whereas a PSB will pay a tax rate of 44%.
Another pitfall of being deemed a PSB is your deductible expenses are heavily restricted (e.g. office expenses, travel, meals and entertainment, etc. will no longer be allowed). Generally, a PSB expenses are limited to salaries and benefits paid to the incorporated employee.
So not only will your business potentially be paying significantly more in income taxes, but your deductible expenses are essentially wiped out. The situation can get even worse if the CRA deems your corporation to be a PSB, but you have been claiming the SBD on prior years tax returns.
This could lead to a large tax bill, as the CRA could potentially go back and reassess the corporations previously filed tax returns denying the SBD and various expenses.
How to determine if you are at risk of being deemed a PSB
When considering if you operate a PSB, the CRA will generally use the following:
- The income that the business earns is from services rendered by an individual (an “incorporated employee”), or an individual related to the incorporated employee.
- The incorporated employee or related individual is a specified shareholder of the corporation. Generally, a specified shareholder is an individual who owns more than 10% of the corporation (or any related corporation) at any point during the year.
- It would be reasonable to conclude that the services provided by the specified shareholder to another entity are of the nature of an employee/employer relationship.
- The corporation providing the services does not employee more than five full time employees.
Essentially, a corporation is at risk of being considered a PSB if the individual shareholder provides services through the corporation and if it wasn’t for the corporation the individual would be considered an officer or employee of the business that it provides services to. For example, if you are an IT consultant who provides full-time consulting services to one company and you bill your services through a corporation, you are at risk of being deemed a PSB.
How to reduce the risk of being deemed a PSB
To reduce your risk of being deemed a PSB you will want to ensure that you are considered an independent contractor by the CRA and not an employee. To determine whether or not you are a contractor or employee, the CRA generally uses the employee vs. contractor test which is summarized below.
- How much control you have over the work performed. For example, to support the argument that it is a business relationship and not an employee-employer relationship you will want to be able to prove and support that you were responsible for planning the work, choosing the hours of work, and are basically in charge of how the work you do is completed and how much you are paid.
- You own all of the equipment required to complete you work.
- You have a chance of profit or loss (you cover all the operating costs).
- Another way to help you argument would be if you have a contract in place that clearly provides an argument in your favour for points 1 – 3.
In addition to ensuring that you are considered a contractor by the CRA it is recommended having the following in place:
- Having several clients that you provide your services to.
- Supplying your own assets that are required to complete the work.
- Properly invoice your clients on a regular basis (i.e. monthly) for the services provided.
- Not having any workspace that is regularly available to you at your clients place of business.
- Not having restrictions placed on your corporation that would normally be applied to employees (ex. exclusivity contracts).
- Your corporation bears some financial risk.
It is important to determine whether or not your business is at risk of being deemed a PSB as the consequences can be costly. If you have questions or would like to discuss your particular situation, please do not hesitate to contact one of our qualified professionals.