A personal services business (PSB) is any person who provides services through a corporation rather than performing those services directly to the company as an employee. These services are usually those that an officer or employee would perform. A personal services business is also known as an “incorporated employee.”
While the concept of a PSB is simple, it can become complicated from a tax perspective. Knowing whether you qualify as a personal services business is critical because it prohibits you from taking the small business deduction and often forces you to use a higher tax rate. Jeremy Scott Law can help with these challenges, from determining whether a PSB classification is necessary to filing tax documents. Call (902) 403-7201 for more information.
Why Does the PSB Classification Matter?
Whether the CRA classifies your business as a PSB will have a huge impact on the applicable tax rate. For instance, an Ontario corporation with less than $500,000 income will be taxed at either the 12.2 percent small business rate or the personal services business rate of 44.5 percent. Further, as a PSB, the business can deduct wages as a business expense, but they cannot deduct much else for business costs.
This difference can mean thousands of dollars in taxes, so for that reason alone, individual business owners need to know whether they are considered PSBs or not. However, other limitations apply as well. A PSB does not benefit from the small business deduction or the general corporate rate reduction.
Understanding the PSB Trend
Many large companies choose to hire independent contractors rather than employees. Hiring an independent contractor means paying far fewer costs than an employee, including things like retirement benefits, insurance payments, and taxes. Businesses have hired independent contractors for their short-term business needs for years. However, there is a recent trend toward hiring long-term independent contractors to provide specific services.
While this structure can provide benefits for both parties, it can have negative tax implications for the individual that might be severe. Understanding these consequences and considering whether they apply to your specific situation will help you determine if this type of independent contractor agreement is a good idea.
Defining a Personal Services Business
A PSB is a corporation. It does not include business relationships where the independent contractor performs services as themselves, such as in a sole proprietorship. However, if someone is acting as an independent contractor in some industries, they might have to form a corporation to comply with certain industry-specific laws. The result is that the individual may be forced into a PSB, even if it was not intentional.
Even if incorporation is not required in a specific industry, taxpayers might still want to incorporate to take advantage of lower corporate tax rates. Businesses pay taxes of 12.2 percent in Ontario and 11 percent in British Columbia. These rates are in stark contrast to the CRA’s reported top tax rates of 53 percent for high-earning individuals in these areas.
What Is a Personal Services Business?
The Income Tax Act defines a personal services business. As a rule, the following conditions will determine whether a business relationship is a PSB.
- The income of the corporation is rendered by an individual, an “incorporated employee”
- The person providing services (or a related person) is a specified shareholder (someone who owns 10 percent or more of the issued shares of any class of stock or any affiliated corporation)
- But for the incorporation, the incorporated employee might be a company officer or employee for which they are working
- The corporation does not employ more than five full-time employees throughout the year
- Services are not provided to an associated corporation
This analysis often focuses on the relationship between the hirer and the independent contractor. If the independent contractor might otherwise be considered an employee but for the corporation, it is much more likely that the business receives a PSB classification.
What Situations Qualify as an Employee-Employer Relationship?
The real test for whether a corporation is a PSB is whether the independent contractor would otherwise be considered an employee. However, that test can be difficult, and it depends on the unique facts of the situation. The Canada Revenue Agency (CRA) uses a few qualifications to determine whether someone might qualify as an employee.
- What kind of control does the hirer have over the contractor’s performance and duties?
- Must the contractor do the work personally or could they hire out the work?
- Does the contractor have any capital investment in the business? Is there a business presence?
- Does the hirer provide the tools necessary for the contractor to do their job?
- Does the contractor have a chance to profit from the relationship? Is there a risk of loss?
- What was the intention of the parties?
- Is there a written agreement that defines the relationship between the parties?
As a rule, the more independent the contractor is, the less likely they are to be considered an employee. The CRA provides some additional guidance on these questions and factors that both companies and independent contractors might want to review. Jeremy Scott Law can also provide guidance about your specific situation to determine how likely the CRA would classify your relationship as between an employer/employee.
Steps to Avoid the Personal Services Business Classification
In some situations, independent contractors might simply want to decline to incorporate to avoid the very negative tax treatment that PSBs receive. However, if you must incorporate, you might want to consider a few actions that could reduce the possibility that the CRA treats your company as a PSB. Below are a few suggestions.
- Work with more than one client or customer, instead of only serving one business
- Take steps to make the corporation look independent, such as having a website and creating business cards
- Set a flexible work schedule instead of permitting the hirer to dictate working hours
- Provide your own tools and equipment
- Negotiate the right to subcontract the work to other people
Every situation is different, so some companies might be able to take the above steps, but they might not be an option for others. Remember, the more independent a corporation is, the less likely the CRA will classify it as a PSB.
Contact a Tax Lawyer for Help with Your PSB Challenges
The CRA reports that it has started reaching out to businesses about PSBs and will continue this type of outreach at least until December 2022. As a result, compliance is especially important. Whether you know you have a PSB or you need additional guidance to avoid the classification, Jeremy Scott Law can help. Contact our office to schedule a confidential consultation by calling (902) 403-7201.