PERSONAL SERVICE BUSINESS
Some businesses wanting the services of an individual insist that the individual incorporate rather than provide services as a sole proprietor. This can be risky for the individual.
In 1981, the federal government introduced rules in response to what it saw as a tax-planning problem. A past or potential employee could incorporate a company, have the company provide services to the employer, and potentially turn what should be employment income into corporate business income eligible for the lower small-business corporate tax rate. In addition the corporation could deduct expenses that they couldn’t as an employee.
Under the current version of the rules, a corporation’s business may be classified under the Income Tax Act as a Personal Services Business (PSB) if the individual would reasonably be regarded as an employee of the client if the corporation did not exist. In determining this, factors such as the degree of control exercised by the client, who provides the tools and equipment, the opportunity for profit or risk of loss, and the nature of the working relationship are relevant.
Having only one client can be an indication that the relationship resembles employment, but having one client does not, by itself, make a corporation a PSB.
If a corporation is carrying on a PSB, the tax consequences can be significantly less favourable than those available to an ordinary small business corporation. PSB income is subject to a higher corporate tax rate, and to severe restrictions on expense deductions. As well the corporation cannot claim the small business deduction on its PSB income.
If the CRA conducts a review or audit and determines that a corporation is carrying on a PSB, it can reassess the corporation’s tax returns for previous years, subject to the normal reassessment rules and any applicable exceptions. This can result in additional tax, interest and potentially penalties.
If you are considering entering into a contract to provide services to a company, and that company insists that you incorporate, it is vitally important that you understand the PSB rules and consider the risk.
If you don’t incorporate, the company that hires you risks the possibility of the CRA deciding that your relationship is that of employer-employee. If that happens the CRA could require the company to retoractively pay CPP, EI and other payroll deductions. By requiring you to incorporate, the company avoids that risk. But while the company avoids risk, you don’t. You may face the risk of the CRA deciding that you have carried on a PSB.
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