In Canada, a Personal Services Business (PSB) is a type of business that the Canada Revenue Agency (CRA) designates under certain conditions. The rules governing PSBs are stringent, and the tax treatment of a PSB is less favorable compared to other types of corporations. Here’s an overview of what constitutes a PSB and its implications:
Definition of a Personal Services Business
A Personal Services Business is typically a corporation that provides services where the individual performing the services (the incorporated employee) would be considered an employee of the client if it were not for the existence of the corporation. In other words, the corporation exists primarily to provide the services of the individual to a single client, and the individual would otherwise be considered an employee of that client.
Criteria for a PSB
The CRA uses several criteria to determine if a corporation is a PSB:
- Control - The client controls and directs the individual's work.
- Tools and Equipment - The client provides the tools and equipment necessary for the work.
- Financial Risk - The individual assumes little to no financial risk and is not responsible for significant expenses.
- Opportunity for Profit - The individual has little opportunity for profit beyond a fixed salary or wages.
- Integration - The individual’s services are integrated into the client’s business in a manner similar to that of an employee.
Tax Implications of a PSB
- Higher Tax Rate
- Income earned from a PSB is subject to a higher corporate tax rate compared to active business income. The federal tax rate on PSB income is 33%, and provincial rates may also apply.
- Limited Deductions
- PSBs are restricted in the types of expenses they can deduct. Generally, PSBs can only deduct salaries and wages paid to the incorporated employee and other employees, as well as benefits and certain expenses directly related to the services provided. Many common business expenses, such as office supplies and travel costs, are not deductible.
- Ineligible for Small Business Deduction
- Income earned from a PSB does not qualify for the small business deduction, which offers a lower tax rate on the first $500,000 of active business income earned by Canadian-controlled private corporations (CCPCs).
Avoiding PSB Classification
To avoid being classified as a PSB, businesses and individuals can take certain steps:
- Multiple Clients
- Providing services to multiple clients rather than a single client can help demonstrate that the individual is operating as an independent contractor rather than an employee.
- Contracts
- Using contracts that clearly define the terms of the working relationship, including control over work, ownership of tools and equipment, and financial risks, can support the position that the individual is an independent contractor.
- Business Practices
- Establishing business practices that align with being an independent contractor, such as advertising services, maintaining a business office, and having a business bank account, can help.
Examples of PSB
- IT Consultants
- An IT consultant who incorporates and provides services exclusively to one company, and whose work is controlled and directed by that company, may be classified as operating a PSB.
- Engineers and Architects
- An engineer or architect working through a corporation for a single client, and integrated into that client’s operations like an employee, may also fall under the PSB rules.
Conclusion
Operating as a Personal Services Business can lead to significant tax disadvantages, so it’s important to carefully evaluate your business structure and seek professional advice if necessary. Understanding the criteria and implications of PSB classification can help you make informed decisions and structure your business to minimize tax liabilities.
For more information, refer to the CRA's guidelines on PSBs and so that you set up your PSB correctly, contact our office first.