Many professionals choose to incorporate to take advantage of the benefits that corporations can offer, including liability protection, tax planning opportunities, and business flexibility.
But not every incorporated business receives the same tax treatment.
If you have an incorporated business and mainly provide services to a single client, the Canada Revenue Agency (CRA) may classify your business as a Personal Services Business (PSB).
If you are classified as a PSB, there can be significant tax consequences, including higher corporate tax rates and restrictions on deductible expenses.
At KD Professional Services, we help incorporated businesses understand their tax obligations and avoid costly surprises. Understanding the rules regarding Personal Services Businesses is an important part of effective tax planning.
What Is a Personal Services Business?
A Personal Services Business (PSB) exists when an individual provides services through a corporation but would otherwise be considered an employee of the client if the corporation did not exist.
In simple terms, the CRA may view the corporation as merely an intermediary between the worker and the company receiving the services.
The CRA reviews these situations because incorporating should not be used solely to obtain tax advantages that would not otherwise be available to an employee.
How Does the CRA Determine if a Business Is a PSB?
The CRA reviews several factors when determining whether a corporation is operating as a Personal Services Business. Generally, a PSB may exist if:
1. The Individual Is a significant shareholder of the corporation. The person providing the services is a significant shareholder of the corporation and owns, directly or indirectly, at least 10% of any class of shares.
2. The Individual Would Otherwise Be Considered an Employee. If the corporation did not exist, the individual would likely be considered as an employee of the company receiving the services rather than an independent contractor.
3. The Corporation Has Five or Fewer Full-Time Employees. A corporation that does not employ more than five full-time employees throughout the tax year may be more likely to meet the PSB criteria.
4. The Income Is Not Earned Through a Related Corporation. The amounts received for services are not paid by a related secondary corporation.
Why Does PSB Status Matter?
The biggest issue for incorporated professionals is the tax treatment applied to a Personal Services Business. Many of the tax benefits generally available to Canadian-controlled private corporations (CCPCs) are not available to a PSB. As a result, a PSB may face a significantly higher tax burden.
Higher Corporate Tax Rates
One of the most significant tax consequences of being a PSB is that the corporation is generally not eligible for:
- The Small Business Deduction
- The General Tax Rate Reduction
These tax measures can help many businesses reduce their overall corporate income tax rates.
Limited Expense Deductions
Another major disadvantage of a Personal Services Business is that deductible expenses are significantly limited.
Unlike most corporations, which can deduct many business expenses, a PSB may only deduct specific allowable expenses. These generally include salary and wages, employee benefits and allowances, certain selling and contract negotiation expenses and legal collection expenses.
How to Reduce the Risk of Being Classified as a PSB
Every situation is different, but businesses may reduce the risk of PSB classification by demonstrating characteristics associated with independent businesses, such as:
- Having multiple clients
- Assuming financial risk
- Providing their own tools and equipment
- Maintaining control over how work is performed
- Hiring employees or subcontractors
- Operating independently from the client’s day-to-day management
Because CRA evaluates each situation based on specific facts and circumstances, professional advice is essential.
How KD Professional Services Can Help
The distinction between an independent corporation and a Personal Services Business can have a significant impact on your tax obligations. Proper tax planning and business structuring can help ensure compliance while maximizing available tax opportunities.
At KD Professional Services, we work with incorporated professionals, consultants, contractors, and small business owners throughout Canada. We can help determine whether your corporation may be at risk of PSB classification and assist you in developing a tax-efficient business strategy. Contact us today for a free consultation.