Personal Services Business – Avoid the Trap
The last thing you want when you incorporate your business is for the Canada Revenue Agency (CRA) to label you a Personal Services Business (PSB).
If the CRA determines an incorporated individual working as a contractor is just an employee of the company they are working for, they would be deemed a personal services business.
This is a costly category that has become a problem for many Ottawa consultants who are encouraged by some staffing agencies to incorporate before getting federal government work. Some agencies will not represent non-incorporated consultants. It’s a Catch-22.
If consultants do not incorporate, they are told they will not be hired; but, when they do incorporate, the scope of the work may appear, in the eyes of the CRA, to be no different than that of a regular employee. Hefty tax consequences could result.
Personal Services Business or Corporation?
It is important to note that the personal services business designation is a year-by-year label. Hypothetically, you can be labeled a personal services business one year and a proper corporation the next. Each year is judged on the merits of the corporation’s activities in that taxation year.
Disadvantages of Being a Corporation
One major disadvantage of a personal services business is that the corporation cannot claim the same expenses as a small business.
A second disadvantage is, the corporation would lose its eligibility for the Small Business Deduction (SBD), which, in Ontario, means its tax rate would increase from 15 per cent to 26.5 per cent. The corporation would also lose its 13 per cent general rate reduction, triggering a 39.5 per cent tax rate.
The 2016 Federal Budget increased the federal corporate tax rate for personal services businesses by 5% to 44.5%. On $100,000 of corporate income, this would leave $55,500 of after-tax corporate income to be paid out.
The law states that a contractor will be declared a personal services business if, without being incorporated, the contractor could reasonably be considered an employee of the would-be-employer.
The exceptions are: the corporation employs more than five full-time employees over the course of the year; or, the services are provided to an associated corporation.
This article is, by no means, meant to discourage anyone from incorporating as a professional or consultant. There are many advantages to incorporating, and despite the possible pitfalls, it may be beneficial for you to do so, but it’s complicated and can be confusing. Talk to a specialist offering tax services before you decide.