Tax implications for a personal services business
Understanding the nature of your business arrangements is essential when it comes to complying with your tax obligations. If you have incorporated your business to provide services to one other company you might be considered to be operating a personal services business (PSB) by the Canada Revenue Agency (CRA).
It is important that you are aware of the tax implications of incorporating and operating a personal services business. There may be legal and/or financial consequences for failure to report appropriately.
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Determining if your business is a personal services business
Generally speaking, a personal services business exists where the individual performing the work would be considered to be an employee of the payer if it were not for the existence of the corporation. This structure is sometimes referred to as an incorporated employee.
Your corporation may be operating a personal services business if the following conditions are met, as outlined in the Income Tax Act:
- you, as the incorporated employee performing services, is a specified shareholder of the corporation;
- if the corporation did not exist, you, would be considered an employee of the entity receiving the services;
- your corporation does not employ more than 5 full-time employees throughout the tax year; and
- the amounts received by your corporation for services were not received from a related secondary corporation.
Tam is looking for a job. An Ontario-based trucking company (ABC Trucking) offers him a 12-month contract position with full-time hours. The contract comes with the stipulation that Tam perform his services through a corporation.
Tam incorporates his business (858689 Ontario Inc.), for which he is the only shareholder and the only employee. 858689 Ontario Inc.’s only client is ABC Trucking.
858689 Ontario Inc. bills ABC Trucking for the services it performs, and it receives payment from ABC Trucking for those services. 858689 Ontario Inc. either keeps the funds in the corporation or disburses them to Tam.
In this example, 858689 Ontario Inc. meets the conditions outlined in the Income Tax Act to be considered a personal services business because:
- Tam is a specified shareholder of 858689 Ontario Inc.
- Tam performs the work of an ABC Trucking employee using their trucks, and were it not for the existence of 858689 Ontario Inc. Tam would be considered an employee of ABC Trucking.
- 858689 Ontario Inc.’s sole income is from services performed by Tam (incorporated employee) for ABC Trucking.
Faye is looking to create her own coding and consulting business. She creates a business plan with a couple of friends, and incorporates as 123 Programming Inc. Faye and her two friends become shareholders of the business.
To perform work, Faye and her business partners use the corporation’s computer equipment. Throughout the first fiscal year, the corporation worked for five clients, billed the clients, and disbursed a portion of the payment to the shareholders, while also holding a small portion to pay off corporation expenses. The work they performed ranged from coding an appointment registration application for a hair salon, to consulting with a mall on how to update their networking infrastructure.
In this example, 123 Programming Inc. does not meet the conditions outlined in the Income Tax Act to be considered a personal services business, because:
- Faye and her business partners perform work for clients using 123 Programming Inc.’s equipment, but they do not perform work that an employee of their clients would normally perform.
- 123 Programming’s income is from services performed by more than one shareholder for more than one client.
Since 123 Programming Inc. is not considered a personal services business, they will follow rules and obligations set out in the Income Tax Act for other corporations.
Mia is a nail technician and is looking for a job. A nail salon, 789 Salon, offers her a job but requires Mia to incorporate in order to offer her services at their salon. Mia incorporates as XYZ Nails Inc. and is the only shareholder and employee. She pays a chair rental fee to 789 Salon.
The hiring business, 789 Salon, supplies all the instruments and products required to perform her job as a nail technician.
In this example, XYZ Nails Inc. meets the conditions outlined in the Income Tax Act to be considered a personal services business because:
- Mia is a specified shareholder of XYZ Nails Inc. and its only employee.
- Mia performs the work of a 789 Salon employee using their instruments and products, and were it not for the existence of XYZ Nails Inc. Mia would be considered an employee of 789 Salon.
- XYZ Nails Inc.’s sole income is from services performed by Mia (incorporated employee) for 789 Salon.
Should the conditions of Mia’s business change to include:
- using her own equipment and products,
- making her own appointments,
- advertising XYZ Nails Inc. business,
- hiring other manicurists to sit in her chair at 789 Salon.
There would be an increased likelihood that she would not be considered a personal services business for income tax purposes.
Tax deductions, tax rates, and eligible expenses for a personal services business
If you are an incorporated employee and your corporation is operating a personal services business, your tax obligations are different than other corporations.
Tax deductions and tax rates
A personal services business is not eligible for the general tax rate reduction or the small business deduction, which allow other corporations to reduce their corporate tax rates.
As a result, a personal services business is subject to the full federal and provincial corporate tax rates on all taxable income, plus an additional 5%.
A personal services business is limited in the expenses they may deduct. Expenses that may be deducted by a personal services business are outlined in the T2 Corporation- Income Tax Guide and are as follows:
- the salary and wages the corporation pays to its incorporated employee(s);
- any benefit or allowance the corporation provides to its incorporated employee(s);
- certain expenses of the corporation associated with selling property or negotiating contracts; and
- legal expenses incurred by the corporation in collecting amounts owing.
Filing and payment obligations
A corporation that is operating as a personal services business is required to file a T2 Corporation Income Tax Return and pay any amounts owing to the CRA by the corporate tax filing and payment deadlines, like any other corporation.
When completing the T2 return, however, it is important to remember that a personal services business is not eligible to claim the same tax deductions and expenses that are available to other corporations, and they are subject to a higher tax rate.
For details on how to complete the T2 return, refer to Guide T2012, T2 Corporation, Income Tax Guide 2019.
A personal services business is also responsible for GST/HST withholding, filing, and remitting obligations, for payroll deduction such as CPP/EI, as well as issuing T4 slips for any employees of their corporation.
Correcting tax returns
If you believe you may be operating a personal services business and would like to correct the tax return(s) you previously filed, you can contact the CRA’s Voluntary Disclosure Program to determine if you meet the eligibility requirements and submit an application.
Helping you comply with your obligations
The CRA recently conducted an educational outreach project to help industries that hire personal services business (PSB) understand and comply with their tax obligations associated with this type of arrangement.
We are compiling and analysing the results to help us shape the next phases of the pilot. We will keep you informed soon.
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