Personal Services Business (PSB)
CRA Education Initiatives
Publish at: 2022-09-19
In some industries, it is common for employers to require their workers to provide services through their own corporation rather than directly as employees. In general, a PSB exists where an individual would be considered the employee of the hiring entity if it were not for the existence of the worker's corporation. In a recently released 15-minute video, CRA specifically stated that PSBs are more common in the following industries:
What is PSB?
If you register yourself as a corporation to perform services for a hiring business, you may be considered to be operating a PSB. This structure is sometimes referred to as an incorporated employee.
The CRA might consider your corporation a personal services business (PSB) if:
you, as the incorporated employee performing services, or any person related to you, is a specified shareholder of your corporation
your corporation does not employ more than 5 full-time employees throughout the tax year
your corporation’s income is from services performed by you, as the incorporated employee, on behalf of your corporation
If your corporation did not exist, you, as the incorporated employee, would be considered an employee of the hiring business receiving your services
Note that a specified shareholder is a taxpayer who owns, directly or indirectly at any time in the year, at least 10% of the issued shares of any class of capital stock of the corporation or a related corporation.
Most of the time, corporations of concern can easily fall into the criteria 1, 2, and 3, so to avoid criteria 4 is crucially important. When CRA assesses whether an individual is an incorporated employee of the payor party, they use the same factors used to determine whether an individual is employed or self-employed. You may refer to the following CRA link for an overview of this topic:
Tax consequences of PSB:
If considered a PSB, not only is the small business deduction not available, but the corporation is subject to an additional 5% tax rate, resulting in corporate taxes rate well over 40%. For example, a PSB in Ontario will be subject to a total
corporate tax rate of 44.5%.
Don’t forget that when after-tax earnings are distributed from PSB to individual shareholders as a dividend, the dividend income is subject to personal tax as well. Assuming an individual in Ontario with the top tax rate receiving this dividend income, he/she would pay 21.83% tax, resulting in
a combined tax rate of 66.33%.Had the individual earned that income directly as an employee, the top personal tax rate would have been only 53.53% in Ontario. That is a harsh
12.8% more tax under PSB.
Further, only limited operating expenses are deductible against PSB revenue. Paying salary to the incorporated employee is an effective way to reduce the risk of PSB.
On July 21, 2022, CRA released a stakeholder email announcing the launch of an educational project in respect of PSBs. The email indicated that businesses from specific sectors would be selected; however, the specific industries were not provided. Participation in the project was stated to be voluntary.
CRA officials will contact businesses and ask them to provide documentation on the nature of their payer/payee relationship. As part of the project, CRA will also inform payers and payees of the tax obligations. CRA finally noted that no compliance action will result from this initiative; however, businesses will be advised to ensure that errors are corrected and comply with the Income Tax Act. The project is expected to run until December 2022.
Strategies to reduce/counter PSB risk:
If your corporation provides services to a single client, you may want to assess your risk of being considered a PSB. There are several strategies that can be employed to both reduce the risk of PSB classification and reduce the negative consequences of such a classification. We listed a few below:
Thoroughly review the contract/agreement between your corporation and the payor party, and understand the terms and conditions in the contract that have an impact on determining the relationship of the signing parties. Take proactive steps to assess whether you are in a safe zone.
For people who are comfortable thinking they are not in an employee relationship but need affirmative answers, as CRA suggested on their 15-minute video, ask for a ruling from CRA. However, that certainly will expose all your relevant information to CRA, which would negatively bring CRA’s attention to your case.
PSB tax rates are applied based on net profit. As we mentioned the sole employee’s salary and benefits are fully deductible, providing a chance to lower the net taxable income. Maximize the salary paid to yourself so that the corporation pays little to no tax. We know that dividend mechanism results in higher combined tax, so you are still better off using the salary mechanism in terms of the combined tax.
The bottom line is that operating a PSB is not encouraged at all from a tax perspective. If at any time you think you are at risk of PSB classification, contact us for analysis and risk mitigation.
This article is written only for general information and broad guidance. Please contact our office to discuss your specific circumstances. We are not responsible for any damage resulting from your reliance on the information in this article.