WHAT YOU NEED TO KNOW IF OPERATING PERSONAL SERVICES BUSINESS (PSB)

Individual business owners are looking for ways to minimize tax liabilities. Corporations are looking to subcontract work to small business owners in order to minimize employee benefit expenses such as CPP, EI, Worksafe premium and group insurance.

Individual business owners resulted to incorporating its business to take advantage of the small business and general tax rate deductions available to corporation not knowing the consequences and significant tax implications of Personal Services Business.

Beware that CRA launched a new campaign focusing and escalating their scrutiny on personal service businesses. The consequences for breaching these tax rules can be severe.

To better understand the significant tax implications to PSB and individual business owners, it is imperative to identify the key issue if the individual owner/worker performs services on behalf of their own corporation, the corporation may be considered to be carrying on a personal services business (PSB). The tax obligation depends whether the person is the Payee or the Payer. The Payer is the business receiving the services, who pays the corporation for their services. The Payee is the corporation carrying on a PSB receiving payment for the services rendered.

Under the Income Tax Act (ITA), a business of providing services carried on by a corporation is considered to be a personal services business (PSB) if it meets all 5 conditions below.

1. The worker (shareholder) provided services through a corporation
2. The worker, or a person related to the worker was a specified shareholder of the corporation [specified shareholder is an individual who at any time in the year directly or indirectly owns at least 10% of the issued shares of any class of the capital of the corporation or any other corporation that is related to the corporation]
3. The corporation employs 5 full-time or less employee throughout the year
4. The amounts received by the corporation in the year for its services were not paid by an associated corporation in the year
5. If not for the existence of the corporation, the worker would reasonably be considered an employee of the payer to whom the services were provided.

To illustrate the 5 conditions mentioned above, consider an individual consultant who was a previous employee, have decided to incorporate a company in order to minimize taxes payable. That person performing the services for the corporation is referred to as an incorporated employee and is considered to be operating a personal services business. No associated corporation in this scenario.

Once incorporated instead of getting paid for the services rendered personally, the payer pays the corporation own by the consultant directly. The tax consequences of operating a personal services business is astronomical, all the tax benefits of the corporation will be reversed.

Assuming that CRA determined that the consultant is operating a Personal Services Business, the tax consequences to the Payee Corporation are the following:

1.       The small business and general tax rate deductions claimed by the corporation will be reversed or denied, an additional 5% tax on PSB income will be assessed

2.       All other expenses claimed will be disallowed

3.       The expenses claimed will be limited to:

a.       Salary paid to the incorporated employee

b.       Employer share of the employee benefits such as CPP and EI

c.       If the individual earned commission income, expenses related to the commission will be deductible

d.       Expenses of the corporation associated with the consulting business

e.       Legal expenses incurred to collect amount owing on services provided

4.       Penalties and interest will be assessed upon reassessment of the PSB corporate tax return.

The degree of relationship between PSB and the Payer as well as the control exercised by the payer over the service provider worker are the key factors that determine whether or not PSB exists. Question, is a written contract between the Payer and PSB that outlines the detail work and services sufficient in assessing whether business relationship is in place and not a contract of employment?  Not quite, in a situation whereby a business contract is with only one company, it is reasonably be considered that the individual/worker is an employee of the payer if it were not for the existence of the corporation through which the services is performed.

In order to help the Canadian Corporations operating as a personal services business (PSB) and the companies that hire them understand their tax obligation, CRA launched a PSB pilot study in 2022 and continuing this fall of 2024. CRA key Findings are outlined below:

• Based on the result of the Phase 1 Pilot study of PBS activities, conducted by the CRA, Of the 2,100 corporations that participated, 220 (approximately 10%) were likely to be utilizing PSBs.

• A large portion of potential PSBs (416 – 64%) are incorrectly claiming the small business deduction (SBD), which they are not eligible for as a PSB. Based on data from the pilot, this error would result in a need for the PSB to repay the CRA an average of $16,711 in corporate tax.

• Nearly 74% of the potential PSBs identified work in 3 sectors/industries:
  • Transportation and warehousing (35%) with 95% of those within general freight trucking or specialized freight trucking
  • Professional, scientific and technical services (26%)
  • Construction (13%)

CRA campaign seems to focus on industries that commonly hire service providers who may operate a PSB, such as trucking, IT consulting, accounting, construction and catering.

To avoid the risk of being assessed as a Personal Business Services, an individual planning to incorporate its business should carefully assess the relationship between the Payee and Payer and the control exercised by the payer over the Individual worker. Individuals and Corporations must carefully structure their business relationships to avoid the unintended tax consequences on PBS. The Individual must also seriously assessed the conditions under the Income Tax Act that could lead to CRA declaring the business as PSB.

In conclusion,

In order to prevent CRA’s punitive assessment on PSB, it is extremely important to have a work contract with multiple clients or customers. Establish a business contact such as website that can attract more business. Although the company employs less than 6 fulltime workers, hiring a subcontractors to farm out the workload that creates business expense which directly related to earning business income is a clear indication that the company is generating an active business income, a CCPC that is entitled to small business deductions and other benefits associated to a corporation.