WHAT IS A PERSONAL SERVICE BUSINESS?
According to CRA, “a Personal Services Business (PSB) is a business that a corporation carries on to provide services to another entity (such as a person or a partnership) that an officer or employee of that entity would usually perform. Instead, an individual performs the services on behalf of the corporation. That individual is called an incorporated employee.”
In layman’s terms, a PSB is a person who is providing services through a corporation as opposed to performing that service directly to the company as an employee.
Why is this important to know? When you operate as a PSB, you aren’t entitled to the small business deduction and the low tax rate which is one of the biggest advantages to incorporating.
The federal tax rate for small businesses is currently 11% on the first $500,000 of active business income. If you are considered a PSB, your federal tax rate is 33%. On $100,000 of taxable income, this is $33,000 more in taxes. This is a huge difference!!!
As well, you are not entitled to claim the standard business expenses, such as, accounting fees, meals and entertainment, office supplies and office space. You would only be entitled to claim the salary and benefits paid to the incorporated employee.
Based on the tax difference alone, it is important to determine whether you are an employee or an independent contractor. Being incorporated doesn’t change the fact that you could be considered an employee.
Question to ask yourself is “are you performing a contract FOR services (self-employed) or a contract OF service (employee)? A contract OF service is where a worker is employed as part of the business. Under a contract FOR services, although done for the business, the work is not integrated into it but is only an accessory.
How does CRA determine whether you are an independent contractor vs. an employee? There is not one specific factor that will determine this but rather a combination of these four issues.
- Control of Work – This relates to the degree of control exercised by the hirer. If the independent contractor has control over how the services are performed, then you are likely an independent contractor.
- Ownership of Tools – Owning your own tools generally supports the independent contractor status.
- Chance of Profit/Risk of Loss – Do you have the ability to generate increasing profits and/or suffer financial losses from the activities?
- Integration – From the viewpoint of the worker, this test looks at how well you are integrated into the business. Are you performing the services as a person in business on your own account? If so, you are likely an independent contractor.
Consultants providing services to only one company are generally affected by this. Although some companies may require you to incorporate to work for them, when the nature of the services would otherwise make you an employee, then you are likely considered an incorporated employee or PSB.
Companies often like the option of requesting subcontractors to be incorporated as it reduces their permanent overhead with things like office space, cell phones, computers and supplies, payroll and benefits (EI, CPP, health benefits, pension, WBC, etc). This can often be offset by being paid a higher rate however when you are a PSB and can’t deduct your expenses or take advantage of the small business tax rate, then it may not be advantageous to be incorporated.
Here are just a few suggestions on how to avoid being classified as a PSB.
- Make sure you have more than one client especially in a long term relationship.
- If outsiders looking in would you view you as an employee, then CRA would likely too. Have at least one employee or have the ability to contract the work to someone else.
- Always supply your own tools; i.e. computer, software, office supplies, etc.
- Set your own rates and have the ability to change them at your own discretion.
- Set your hours and days worked.
- If providing services on-site make sure you can come and go as necessary.
If you think you are at risk of being considered a PSB, make sure you consult with a Professional Accountant.
***This blog is for information only and not to be used as tax advice or planning without first seeking professional advice. Information is subject to change without notice.