Personal Service Business Risk
Are you an “Incorporated Employee”?
Plenty of businesses have hired independent contractors rather than employees to meet their staffing needs. There are several advantages of incorporating a company such as:
A small business corporation is generally entitled to the small business tax rate (just 11%) on the first $500,000 of active business income.
Perceived additional write-offs to claim in a company.
For the hiring company, it’s simpler and less costly to hire a contractor over an employee.
The problem, however, is there are rules that will deny the small business deduction and prevent certain individuals from taking advantage of the lower corporate tax rate and write-offs associated with your business.
The tax rules that can catch you are what is referred to as a “personal services business” (PSB).
What are the tax laws to be considered a PSB?
You are a shareholder of the corporation, and you own 10% or more of the company.
If it were not for the company, you’d be considered an employee of the hiring business.
Your company does not employ more than 5 full-time employees throughout the tax year.
Point #2 is what catches most people under the PSB rules.
The reason this catches most people is that you’re simply providing services to just one customer, you do not exercise control over when and where you work, you are providing very little in the way of tools & lastly you are not taking on economic risk (a chance of profit or loss).
Beginning last June, the CRA launched a pilot project to identify more businesses operating as a PSB and to reassess their tax situation accordingly. This initial project was highly successful in identifying PSB’s and they are moving onto Phase II of this project to identify even more PSB’s going forward.
What happens if your company is ruled a PSB?
Two main things happen that will cause you grief on the tax front:
You will be denied the small business tax rate of 11%, and the company will pay a higher corporate rate of 44% on its taxable income.
Your company will be allowed only a deduction for any taxable salary paid to you and limited to other deductions from corporate income.
Bottom line is if this happens to you, then you are better off paying all your income out to yourself as wages to avoid the higher tax rate applied to a PSB. The tax difference is a whopping 33% difference in additional tax if your corporation gets ruled a PSB, and there will also be substantial penalty and interest charged on any tax reassessed.
