Is Your Corporation a Personal Services Business? What You Need to Know

What Is a Personal Services Business (PSB)?

A Personal Services Business is a corporation that provides services to a client, where the worker who performs those services would be considered an employee of that client if the corporation did not exist.

In plain terms, it is a corporation set up to deliver what is essentially employment services, rather than running an independent business in its own right. The CRA created the PSB rules specifically to prevent individuals from incorporating to gain tax advantages that were not intended to apply to what is functionally an employment relationship.

The 5 Conditions for a PSB

Under the Income Tax Act, a corporation is considered a PSB if it meets all five of the following conditions:

1. The worker provides services through a corporation. The individual delivers services to a client by operating through a corporate entity rather than personally.

2. The worker, or a related person, is a specified shareholder of the corporation. A specified shareholder generally means someone who directly or indirectly owns at least 10% of the shares of the corporation at any time in the year.

3. The corporation employs five or fewer full-time employees throughout the year. If the corporation employs more than five full-time employees, the PSB rules generally do not apply. A full-time employee is someone who works a full business day on each working day of the year.

4. The services are not provided to an associated corporation.If the client corporation is associated with the service corporation, the PSB rules do not apply.

5. If the corporation did not exist, the worker would reasonably be considered an employee of the client.This is the most critical condition. The CRA applies the same analysis used to determine employee versus self-employed status, looking at control, tools, financial risk, and the nature of the working relationship.

All five conditions must be met for the corporation to be considered a PSB.

Why a PSB Is Taxed so Harshly

A corporation carrying on a PSB faces a significantly higher tax burden than a regular corporation. Here is why.

No small business deduction. Regular Canadian-controlled private corporations are eligible for the small business deduction, which reduces the federal tax rate on active business income to 9%. PSBs are not eligible for this deduction.

No general rate reduction. Regular corporations also benefit from the general rate reduction, which lowers the federal tax rate on income above the small business threshold. PSBs cannot access this either.

An additional 5% federal tax. On top of the full corporate rate, PSBs are subject to an additional 5% federal tax on PSB income. The combined federal rate can be substantially higher than on regular active business income.

Severely limited expense deductions. A PSB can only deduct:

• Salary and wages paid to the incorporated employee

• Benefits and allowances paid to the incorporated employee

• Certain expenses related to selling property or negotiating contracts

• Legal expenses for collecting amounts owing

Expenses like home office costs, vehicle expenses, and other typical business deductions that an incorporated contractor might ordinarily claim are not deductible for a PSB.

What Happens if You Get It Wrong

Many corporations operating as PSBs file their T2 returns as regular active business corporations, claiming the small business deduction and deducting expenses they are not entitled to. When the CRA identifies this, the corporation faces reassessments, disallowance of ineligible deductions, assessment of the additional 5% PSB tax, and penalties and interest.

The correction process is complex and the amounts involved can be substantial depending on how long the incorrect filing has been occurring.

Obligations as a PSB

A PSB still has the same GST/HST obligations as any other business. It must register, collect, and remit GST/HST if revenues exceed $30,000 over four consecutive calendar quarters.

The PSB also has payroll obligations. If it pays salary or wages to the incorporated employee, it must maintain a payroll account and file the required information returns including T4 slips.

The payer of a PSB, the client receiving the services, must issue a T4A slip to report fees paid for services.

Common Examples of PSBs

• A software developer who incorporates and works exclusively for one client under the direction of that client’s management.

• A consultant who bills through a corporation but works on-site at the client’s location, uses the client’s equipment, and follows the client’s schedule.

• A tradesperson who incorporates and works for a single general contractor under conditions that would look like employment if the corporation did not exist.

Whether a specific situation constitutes a PSB is always a question of fact.

What to Do If You Are Not Sure

The first step is to review your working relationship against the five PSB conditions. If there is any doubt, a professional review before filing or amending returns is essential.

This blog post is for general information purposes only. Every situation is different. Contact us directly to understand how this applies to your specific circumstances.

Source: Canada Revenue Agency, www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/corporation-income-tax-return/tax-implications-personal-services-business/factors-psb.html