3 big risks with a personal service business

/ Business Law Corporate Restructuring Entrepreneurs News

Ringe Bowl for Service (Website Size)

There has been a rise in the number of individuals providing services as independent contractors through a corporation, rather than as employees. Canada Revenue Agency (“CRA”) has increased its scrutiny of this structure. CRA will classify such contractors as personal services businesses (“PSB”).

A PSB is a corporation whose shareholder (holding more than 10% of the shares) would reasonably be regarded as an employee of the company they are working for if not operating via the corporation.

 

Risks of being deemed a PSB

  1. Tax rates

PSB income is not considered active business income by CRA, therefore the tax rate payable will be the standard corporate tax rate, rather than the small business tax rate that is available to Canadian controlled private corporations (“CCPC”).

  1. Business expenses

PSBs are very limited in the business expenses they are able to deduct.

  1. Audit penalties

Corporations that file their taxes as small businesses and are subsequently found by CRA to be PSBs are subject to penalties and tax audits. If your corporation is classified as a PSB as result of an audit, you may be re-assessed and penalized for years of back taxes.

 

Factors in a corporation PSB being deemed a PSB

There are a number of factors that CRA will consider in determining whether a service provider is an independent contractor or a PSB. The primary test is: if not for the individual’s corporation, would they be deemed an employee of the entity for which they are providing a service? If so, they would be considered an incorporated employee and deemed a PSB.

Factors to determine whether an individual is a contractor or an incorporated employee include:

  • whether or not the corporation through which they are providing the services has fewer than five employees;
  • whether the individual provides service to a client in a way that would be considered an employee-employer relationship; and
  • whether or not the corporation’s revenue comes from a single client.

 

Ways to Reducing the risk of being deemed a PSB

To reduce the risk of being deemed a PSB, having a clear distinction from the business relationship of employee-employer by way of contractor agreement is crucial.

Other steps that a corporation can take to mitigate the risk of being considered a PSB include:

  • ensuring that the contractor agreement clearly satisfies the requirements of a contractor relationship;
  • not being bound by non-competition provisions with the entity that services are being provided to;
  • having full control over the manner in which the services are provided to the client;
  • having ownership of tools and equipment; and
  • having a low degree of integration into the entity for which the corporation is providing services.

The degree of integration would involve factors such as whether the contractor receives healthcare, parking or other benefits from the company they are providing services to and other activities that would be common for employees of the company.

 

If operating as a PSB

While PSBs are not able to enjoy the small business deduction that is available to CCPCs, the standard corporate tax rate that would be payable as a PSB, even in addition to any personal taxes paid by the individual as a top-up may not be significantly higher than personal income tax paid if the individual was an employee.

As we are unable to give tax or accounting advice, we recommend discussing tax issues surrounding PSBs with your accountant. We would be happy to liaise with your accountant on this.

We would love to meet with you if you are interested in learning more about PSBs, you and the law. Come by our office for coffee and a consultation.

About these authors: Claudius du Plooy has over ten years of experience in matters of business law, securities law, commercial real estate development, entertainment law and international trade law. Shannon Mitchell is an associate at Du Plooy Law. She recently completed a Post-Baccalaureate Certificate in Natural Resources, Energy and Environmental Law as a graduate student in the law faculty at the University of Calgary.