Did you receive a call from the Canada Revenue Agency (CRA) confirming the status of your business as personal services business (PSB)? In the second half of last year, the CRA launched a campaign to spread awareness among individuals working as incorporated employees about the Personal Services Businesses (PSB) tax rules. 

If you are still doubtful about PSB, read further, as you could face a combined corporate and personal tax rate of over 65% on your PSB income. And if the CRA is assessing more than one year at a time, you are up for a tax shock. 

How Will the CRA Determine Your Corporation Is a Person Service Business? 

Many companies hire incorporated service providers to save on employee costs like withhold tax, Canada Pension Plan (CPP), and Employment Insurance (EI). In addition, service providers working only for one company incorporate their business to enjoy lower corporate tax rates, tax deferral, and tax deductions. 

To prevent this situation, the CRA listed four conditions that determine your PSB status: 

• First, after removing the corporation, are you operating as an employee? 
• Are you the specified shareholder of your corporation? 
• Does all your corporation’s income come from your services? 
• Does your corporation have less than five employees throughout the tax year? 

If the answer to all four questions is a unanimous yes, you could face serious tax implications. 

For instance, John incorporates his IT consulting firm JIT Inc. in Ontario. He is the sole shareholder and employee of JIT Inc. and performs IT consulting for POR Pvt Ltd. JIT Inc.’s only source of income is from John’s services to POR Pvt Ltd. The CRA will categorize JIT Inc. as a PSB and imply two tax implications. 

Tax Implication If the CRA Considers Your Corporation to be a Personal Services Businesses (PSB)

Once the CRA establishes that your corporation is a PSB, it will take away all the tax benefits a corporation gets and tax you as an individual employee. Your PSB will face two significant tax implications. 

1 – The CRA Will Remove Tax Deferral for PSB 

The federal tax rate for personal income is 33%. But if you are a corporation, the federal tax rate reduces to 28%, and if you qualify for the small business deduction, the federal tax rate is 9%. In the above example, POR Pvt Ltd. pays $80,000 to JIT Inc. for IT consulting services. JIT claims small business deductions in which it gets taxed at a rate of 9% for the initial $500,000. 

John will incur individual income tax on the amount he withdraws from JIT. So if he withdraws $50,000 that year by paying a dividend to himself, he gets taxed at a 15% federal rate plus a 5.05% provincial rate of Ontario. This way, John defers his personal tax by keeping the money in the company. 

Now that the CRA has established JIT Inc. as a PSB, it will eliminate John’s small business deduction and charge JIT Inc. 28%. It will charge an additional 5% tax on the PSB income, bringing the total tax rate to 33%. This 5% tax removes the tax benefit John would have gotten for incorporating its services. 

The above 33% tax is what JIT Inc. will pay. When John withdraws his income from the company, he will pay regular income tax. After adding the minimum individual federal tax rate of 15%, John’s federal tax rate comes to 48%. If we add Ontario’s provincial tax rate of 5.05% for individuals and 12.2% for corporate, John’s total tax rate will come to 65.25%. Even the highest individual income tax rate in Ontario is 53.53%. This implication will put you at a tax disadvantage with the PSB. 

2 – The CRA Will Limit the Tax Deductions Personal Services Businesses (PSB) Can Claim 

The second tax blow will come from the reduction in tax deductions. Corporations can deduct business expenses like stationery, equipment and vehicle costs from their taxable income. Once the CRA establishes your corporation as PSB, it will limit the tax deductions to three: 

• Salary paid to the incorporated employee. 
• Employee benefits like CPP and EI are offered to incorporated employees.
• Legal expenses incurred to collect any dues. 

In the above example, if John withdraws $50,000 as salary, he can show that as a business expense and reduce his taxable income for JIT Inc. But he will also have to deduct CPP, EI, and withholding tax from the $50,000 salary. In this case, JIT Inc. will also have to pay the employer contribution of CPP and EI on the $50,000 salary. 

The above tax implications make PSB unattractive as incorporation brings additional administrative and accounting costs.

How To Avoid Being Categorised Personal Service Business? 

You can avoid the above tax implications by clearly establishing your working relationship with the company in a written agreement. But that won’t suffice as actual working conditions may differ. Hence, ensure you run your business, use your equipment, determine your work schedule, have multiple clients, and hire employees. 

Nonetheless, it is a subjective matter. Hence, it is better to get professional help. A tax consultant can help you determine the status of your business and guide you on the right way to save taxes. 

Contact Glenn Graydon Wright LLP in Oakville for Tax Advice

A skilled tax advisor can help you plan your business status and avoid such tax implications. At Glenn Graydon Wright LLP, our tax experts can provide services to support your tax planning and filing, whether you need partial or complete support. To learn more about how Glenn Graydon Wright LLP can provide you with tax planning expertise, contact us online or by telephone at 905-845-6633.