Personal services business: when an incorporated contractor is treated like an employee
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A corporation that provides one person’s services to another business can lose the small business deduction and pay extra tax.
Short answer: the CRA treats a corporation as a personal services business (PSB) when a person who owns at least 10% of it, or someone related to that person, does work for another business that would make them that business’s employee if the corporation did not exist, the corporation has five or fewer full-time employees throughout the year, and the money does not come from an associated corporation. A PSB pays the full federal and provincial corporate tax rates, an additional 5% tax, and cannot claim the small business deduction or the general tax reduction.
The conditions
- You, or someone related to you, is a specified shareholder: an individual who at any time in the year owns at least 10% of the issued shares of any class of the corporation or of a related corporation.
- The corporation provides services to another business, such as a client or hiring company.
- Without the corporation, the individual doing the work would reasonably be considered an employee of that business.
- The corporation has five or fewer full-time employees throughout the year.
- The payments the corporation receives are not from an associated corporation.
A person who incorporates in order to provide services to one other business might be treated as operating a PSB. The CRA has a page of factors it uses to judge whether the person would be an employee, and it is the place to start.
What it costs
- The corporation pays the full federal and provincial corporate tax rates.
- An additional 5% tax applies to PSB income, since 2016.
- The small business deduction and the general tax reduction are not available.
- Deductions are limited: salary and wages paid to the incorporated employee, benefits and allowances provided to that employee, certain expenses of selling property or negotiating contracts, and legal expenses for collecting amounts owed to the corporation.
What your records need to show
- The contract, and how much control the client has over the hours, the place and the way the work is done.
- How many clients the corporation has, and how many full-time employees, since both bear on the test.
- Who owns the shares, with the percentages, because the 10% test counts related people.
What is a personal services business?
A corporation that provides an individual’s services to another business, where that individual would reasonably be an employee of the business if the corporation did not exist, and the other conditions are met.
Does having five employees take me out of it?
The test counts full-time employees throughout the year. A corporation with five or fewer can be a PSB. A corporation with more than five is not one.
What extra tax does a PSB pay?
The full federal and provincial corporate rates plus an additional 5%, with no small business deduction and no general tax reduction.
Does it matter if the client is an associated corporation?
Payments from an associated corporation are outside the PSB test. Related and associated are different tests, so check which one describes your client.
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