Personal Service Business – If you are a consultant or contractor, it is important to understand the tax impact of PSB

In this Blog you will learn:

What is a Personal Service Business?

An example of a Personal Service Business

Potential Risk of the Canada Revenue Agency declaring your business as a Personal Services Business

How to Avoid CRA declaring you as a Personal Service Business

What is a Personal Service Business?

The Canada Revenue Agency defines a Personal Service Business as the following:

• An individual performs services on behalf of the corporation
• This individual is a shareholder of the corporation
• If not for the corporation, this relationship could be regarded as an employee/employer relationship
• The corporation did not employ more than five full-time employees during the fiscal year

An example of a Personal Service Business

Andrew is an IT consultant who is hired as a self-employed consultant and not an employee by a Bank A.

Andrew incorporates “Andrew Inc.” and is the only shareholder and worker. Andrew Inc. has no other sources of income.

Bank A pays Andrew Inc. based on Andrew’s time. Bank A controls when and how Andrew works (just like an employee).

Accordingly, Andrew Inc. is considered a Personal Service Business since it meets the 4 defined criteria:

1. Andrew provides IT consulting services on behalf of Andrew Inc.
2. Andrew is the shareholder of Andrew Inc.
3. If it were not for Andrew Inc., Andrew would be considered an employee of Bank A
4. Andrew Inc. does not have any other employees

Potential Risk of the Canada Revenue Agency declaring your business as a Personal Service Business

You are no longer eligible for small business deduction rate of 17.3% to reduce corporation taxes.

You are very restricted in the types of expenses the corporation can deduct for tax purposes.

Personal Service Businesses are only allowed the following expenses:

• Salary paid to the incorporated employee of the corporation
• Cost of any benefit or allowance provided to the incorporated employee
• Costs related to selling property or negotiating a contract by the corporation if it would have been required for the employee to pay the amount under the employment contract.
• Legal expenses incurred by the corporation to collect amounts owing on services provided.

You will no longer be self employed, and as such you will no longer be able to claim expenses such accounting fees, legal fees, supplies, or your office expenses.

Potentially the most devastating result of this change is the possible tax penalties arising from reassessment. You could end up with a large amount owing because you filed incorrectly when claiming your business expenses and Small Business Deduction. You may find yourself owing back taxes for a period of several years.

How to Avoid CRA declaring you as a Personal Service Business

One of the most important things you can do is avoid working for a single client, especially in an ongoing, long-term relationship. You have a better chance of avoiding the personal service business designation if you are dealing with multiple clients. You do not want to risk being seen as the employee of a specific client.

Having an employee– even if you do not have the suggested 5– is also helpful and is something that the CRA will consider in determining your status.

There are 4 other issues that will be looked at by the CRA when they assess whether a person is operating as an independent contractor:

• The amount of control over the work that a contractor has
• Subcontracting work or hiring assistants
• Ownership of tools
• The risk of loss/chance of profit that the contractor faces

Ensure that you have a written contract detailing all the services that you are providing to your client, and the contract must state that you are self employed.

Conclusion

Make sure you have a written contract stating you are self employed, you have control over the work you do, you own the tools you use, you subcontract work, and you are compensated by a flat fee and incur expenses in carrying out your services. Avoid working for a single client, it is better to deal with multiple clients and have an employee or subcontractor.