What is a Personal Services Business?
CRA says that a personal services business (PSB) is a corporation that provides services to another entity that an officer or employee of that entity would usually perform. More simply said, and in CRA’s terms, it is basically an incorporated employee.
CRA has also been very clear with respect to what qualifies as PSB income. Income earned by the corporation will be considered PSB income if:
1. The incorporated employee who is performing the services, or any person related to him or her, is a specified shareholder (taxpayer owning, directly or indirectly at any time during the year, at least 10% of the issued shares of any class of the corporation or relation corporation) of the corporation; and
2. The incorporated employee would, if it were not for the existence of the corporation, reasonably be considered an officer or employee of the entity receiving the services.
Having said that, there are two exceptions. A corporation will not be considered a PSB if:
1. The corporation employees more than five full-time employees throughout the year; or
2. The corporation provides services to an associated corporation.
Consequences of a PSB
The PSB rules were basically put in place by CRA to discourage employees from incorporating themselves and to prevent them from benefiting from certain tax advantages. A few of the most significant consequences of operating a personal services business include:
1. Small business deduction is disallowed
– Combined federal and provincial (Ontario) corporate tax rate (2015) is increased to 39.5% versus 15.5%
2. Numerous deductions of expenses are disallowed
3. CRA may reassess you for multiple years and apply interest and penalties
In determining whether you are operating as a PSB, you must consider the factors discussed in the common ‘employee’ versus ‘subcontractor’ debate. CRA will consider several factors in determining whether you are operating a PSB.
Factors CRA considers
Although it is sometimes a grey area, CRA has many considerations in makes in determining your status of a PSB.
1.Control
– If the employer controls you and what you do (e.g., hours, location, reporting requirements), CRA may look at you as a PSB.
2. Tools and equipment
– If the employer provides you with tools and equipment (e.g., laptop, cell phone, automobile), CRA may look at you as a PSB.
3. Subcontracting work
– If the employer has stipulated that you are not permitted to hire subcontractors to conduct the work, CRA may look at you as a PSB.
4. Financial risk
– if you are not taking on financial risk (e.g., employer pays for several costs that an independent business would otherwise pay for, you are not liable for poor work performed for the customer), CRA may look at you as a PSB.
5. Opportunity for profit
– If you are limited to your opportunity for profit (e.g., you are paid a straight hourly rate), CRA may look at you as a PSB.
6. Financial dependence
– If you are financially dependent on the employer (e.g., it is your only customer), CRA may look at you as a PSB.
How to avoid being a PSB
You should ensure you take several proactive steps to prevent yourself from being considered a PSB. Looking at the above factors that CRA considers, you may be able to structure your arrangement with the entity to ensure that you are, in fact and in appearance, not an incorporated employee. This is most often done through verbal and written discussions and agreements between yourself and the entity. Not only should these agreements be in place, you should actually be conducting your business in a manner in which it does not satisfy CRA’s criteria of a PSB.
1. Control
– Contract should state that you will be working independently. More specifically, you will be working without direct or indirect supervision.
2. Tools and equipment
– Contract should state that you will be responsible for providing your own tools and equipment. More specifically, you will not be using the entity’s supplies.
3. Subcontracting work
– Contract should state that you will be allowed to use subcontractors at your discretion.
– You should consider actually hiring other individuals to complete, at least, smaller tasks.
4. Financial risk
– Contract should state that you are ultimately responsible for expenses incurred to complete the job.
5. Opportunity for profit
– Contract should state that you may earn profits above and beyond time and materials.
6. Financial dependence
– You should consider maintaining or actively pursuing multiple customers.
