Personal Services Business – Avoid the Trap
The last thing you want when you incorporate your business is for Canada Revenue Agency (CRA) to label you a personal services business (PSB). If CRA determines an incorporated individual working as a contractor is really just an employee of the company they are working for, they would be deemed a PSB – a designation that comes at a great cost to the individual.
This has become a major problem in Ottawa over the last several years, because, as a government town, professionals and consultants are encouraged by some staffing agencies to incorporate in order to be hired by the government. It’s a “Catch-22” in that, if they do not incorporate, they are told they would not be hired; however, when they do incorporate, the scope of the work may appear, in the eyes of CRA, to be no different than that of a regular employee and they can face hefty tax consequences.
It is important to note the PSB designation is a year-by-year label. Hypothetically, you can be labeled a PSB one year and a proper corporation the next. Each year is judged on the merits of the corporation’s activities in that taxation year. Confused? You should be, because it can be confusing, which is why you should always consult your tax advisor before incorporating your business.
One major disadvantage of a PSB 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, causing you to be taxed at 39.5 per cent.
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. This can be paid as eligible dividends, and the overall tax rate (personal and corporate) would be 46.1% where this was the only income, and 66.3% where the individual is in the highest tax bracket with taxable income greater than $220,000. These rates are much higher compared to 25% and 53.53%, respectively, personal income tax rates if the $100,000 was paid as salary.
The bottom line is, the penalties, which may include gross negligence penalties, are severe, so speaking to your accountant about ways to ensure you avoid the PSB label is very important. You can plan ahead, as well, if you and your accountant believe being deemed a PSB is possible in a specific taxation year. You can pay all income out as a salary, in order to prevent the punitive additional taxes from being assessed.
The law states, you will be declared a PSB if, without the existence of the corporation, an individual, or a relative performing service on the corporation’s behalf, 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 you from incorporating yourself as a professional or consultant. There are still many advantages to incorporating. As a matter of fact, depending on your situation, it may still be very beneficial for you to do so.