Canada Revenue Agency (CRA) defines that personal service business (PSB) is a business which provides services to another entity that an officer or employee of that entity would usually perform. Instead, the individual is performing the job through a corporation, and that individual is called as an incorporated employee.
Conditions to Qualify for Personal Service Business Income
According to CRA following conditions are to be met in order to consider your corporation’s income derived from personal service business, they are:
- The incorporated employee or persons related to you is a specified shareholder of the corporation. Here specified shareholder means a taxpayer who, directly or indirectly, at any time in the year owns at least 10% of the issued shares of any class of capital stock of the corporation.
- The incorporated employee would reasonably be considered an officer or employee of the service recipient entity if it were not for the existence of the corporation.
Factors to Determine Whether or not You Act as an Employee or a Self-Employed
Now it is important to determine whether or not the incorporated employee acts as an employee or as a self-employed individual. Following factors determine this status. Review CRA guide RC4110 (Employee or Self-Employed?) to learn more about this in details:
If the employer controls and supervises your work, hours, location, reporting requirements, etc. CRA may view this as a PSB.
- Tools and equipment
If the employer provides you with required tools and equipment such as the computer, software, operating equipment, then CRA may view this as a PSB.
- Subcontracting work
If the employer requires only you to perform the job, then CRA may view this as a PSB.
- Financial risk
Due to poor performance or substandard work for a customer if the employer suffers a loss that you are not required to compensate, then CRA may view this as a PSB.
- Investment and management
If you are financially dependent on the employer (the only customer), then CRA may view this as a PSB.
- Opportunity for profit
If you have very little opportunity for profit because you are paid hourly basis and your hours are controlled by the employer, then CRA may view this as a PSB.
Tax Consequences of Personal Service Business Income
- PSB income is taxed at a higher rate; in 2017, combined Federal and Ontario rate is 44.50% as compared to small business tax rate of 15% combined.
- PSBs do not qualify for a small business deduction.
- Deduction of business expenses is restricted mostly to salary and benefits and legal expenses incurred to collect the contracted amount.
How to Avoid PSB Classification
Some proactive actions may help to avoid your corporation being classified as a PSB, they are:
- If your corporation employs more than five full-time employees throughout the year or provides services to an associated corporation, the corporation will be eligible for small business deduction, meaning that it is eligible to pay corporate tax at a lower rate prescribed for small businesses.
- Instead of providing services to only one or two common long-term contractual customers, try onboarding more customers having short or long-term contracts. You need to actively pursue more customers.
- Invoice your client per contractual payment term on a regular basis as if you are an external service provider; do not let your customers create invoices for you.
- Terms and conditions of the contract should be negotiated as such that you will work independently with very little or without supervision. Also, contractual terms should allow you to control your hours and location of work, employ your own tools and equipment, hire workers or subcontractors for even small tasks, and take risk and responsibility of expenses to complete the job.
- Most importantly, the contract should state that you will have the opportunity to earn more profits above and beyond time and tools you employed.
- It’s better to consult a Chartered Professional Accountant before undertaking a job and ongoing basis to determine the PSB status and tax consequences specific to your scenario.
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