It seems that more individuals are using corporations to carry on and report their income from their consulting-type business. There are a number of reasons why this is, including tax savings and legal liability protection. It could also be that the consultant’s client prefers to contract with a company and not directly with the consultant. With this trend, the scrutiny of the “Personal Services Business” rules are becoming a focus point for the CRA.
But what is a Personal Services Business (PSB)?
There are 4 main characteristics of a Personal Services Business:
- Services are provided by an individual on behalf of his corporation, often referred to as an “incorporated employee”;
- The incorporated employee is a “specified shareholder” of the company (owns at least 10% of company stock);
- The incorporated employee would be considered an employee of the client if the individual provided the services instead of the corporation; and
- The corporation employs less than 5 employees.
Tax Implications
If the corporation carries on a PSB, there are tax implications to consider.
Income from the PSB is reported on a T2, Corporation Income Tax return, and you might think would be subject to the low small business tax rates, but income from a PSB does not qualify for the small business deduction or the general tax rate reduction. On top of that there is an additional 5% tax bringing the total corporate tax rate to approx. 44%.
In addition, no deductions may be taken to reduce PSB income other than:
- Salaries/wages paid to incorporated employees;
- Legal expenses incurred in collecting outstanding payments;
- Allowances provided to incorporated employees; and
- Expenses related to selling property or negotiating contracts.
The primary intent of the PSB rules is to prevent the conversion of higher-taxed employment income into lower-taxed corporate business income by providing services through a corporation. Individuals who carry on their services/consulting-type business through a corporation run a risk that CRA would seek to apply the PSB rules. If CRA is successful, the result would be a large tax bill plus interest and penalties.
CRA Increasing Scrutiny of Personal Services Businesses The CRA has recently let it be known that there is a concern that potential for PSB activity has increased over the last number of years. The first step for CRA will be to focus on increasing education for those
that may be carrying on a PSB or enter into contracts with companies that carry on a PSB. They have launched an education outreach project to help corporations understand the tax obligations, including webinars and sending out “educational” emails and letters. The CRA also announced that between June and December 2022 they would be contacting businesses from different industries that might carry on a PSB to request documentation about the nature of their relationships with payees. While this project is entirely voluntary, it could be highly beneficial to corporations as it will provide feedback and help understand their tax requirements. This will help prevent future errors and avoid penalties and interest for filing incorrectly. Any errors detected during this project will not be subject to any penalties at this time, but the errors would need to be corrected.
As the CRA is putting such a focus on the topic of PSBs, it is anticipated that their scrutiny of classifying corporations as carrying on a PSB will increase in the near future. This makes it even more important to confirm if the Personal Services Business rules apply to you and what that means for you.
Reach out to your trusted Welch LLP advisor if you think the PSB rules might affect how you report your business income. We can help mitigate your risk of a CRA PSB assessment.
Author
Marcy Davis
Tax Technician
[email protected]
