CRA is looking closer at personal services businesses and reaching out to Canadian businesses to voluntarily take part in an education program.
Personal Services Business (PSB), also known as an incorporated employee, provide services where:
The business owner would be considered an employee of the business that services are provided to.
How do you determine whether your business is a PSB?
There are four tests in determining PSB:
1. The incorporated employee is the shareholder of the corporation
2. Services provided directly without using the corporation.
3. The corporation doesn’t employ more than five full time employees.
4. Income generated from services performed by the incorporated employee/PSB on behalf of corporation.
Who is an incorporated employee/PSB
The rules determining an incorporated employee/PSB are based on several factors:
• Control– how much control does the PSB owner have over their own schedule? Are the obligated to schedule set out by the business they are serving?
• Tools and equipment– Does the PSB owner provide their own tools or are they dependent on using the tools/equipment of the business they are serving?
• Ability to subcontract– Can the PSB owner seek other contracts?
• Financial Risk– the PSB/incorporated employee takes on the financial risk of owing a company.
• Opportunity for profit– the opportunity to generate a profit is held with the PSB/incorporated employee
• Multiple clients-The business provides similar services to other clients.
What are the allowable deductions for PSB/incorporated business?
If the business is considered as PSB, the following deductions can be claimed:
• Salary paid to incorporated employee.
• Cost associated with any employment benefit provided to incorporated employee.
• Legal expenses incurred by the corporation to collect amounts owing to it.
Calculation of tax on PSB income
In the calculation of PSB, general rate reduction or small business deductions are not allowed. The result of this is that the PSB is taxed at the full corporate rates (federally and provincially) plus an additional 5%.
What happens if CRA deems your corporation a PSB?
If denied as an incorporated employee, there is the risk that the PSB owner and the corporation that receives the services could bear the tax risk related to income tax, CPP and EI withholdings, in addition to any interest and penalties.
How to manage PSB risk:
1. Paying out salary from PSB– Salary is the one of the few qualified deductions a PSB have. This will reduce the corporate income could be taxed at PSB rate. Any unpaid remuneration is only deductible from PSB income when it is paid.
2. Documenting the relationship– There should be a clear, written agreement outlining the relationship.
3. CRA Ruling– Obtain a ruling from CRA on whether your business is a PSB or not.