There are some new rules that business owners of certain Canadian incorporation should keep in mind when structuring their personal service business (PSB). We often get asked what the best structure is for individuals when they are thinking of setting up a self-employed consulting business.
The typical discussion starts with, “should I be a sole proprietor or should I incorporate”? There are some interesting developments concerning the enforcement of the rules from Canada Revenue Agency (“CRA”) that should make more people sit up and pay attention.
Detailed below we hope to shed some light on the tax implications of incorporation.
What is the tax issue that is so concerning when incorporating?
With so many people wanting more flexibility in their lives there has been a growing trend to work as a consultant to maximize lifestyle opportunities and independence. One of the ways of entering in a relationship to provide services was to incorporate. Incorporating as a Canadian controlled private corporation (also known as a CCPC) allowed individuals to take advantage of the small business deduction on the first $500,000 of active business income. Additionally there are two other potential savings in income splitting and tax deferral.
CRA is concerned about potential abuse arising from the use of this structure which allows individuals to incorporate and offer their services to employers vs. being employed directly. As discussed above the benefits of the incorporation was to gain access to the small business rates. In recent years there have been several court challenges that forced the hand of CRA to implement new rules concerning personal services businesses or “PSB”.
How do I know if my business falls under the rules of a PSB?
The main criteria for determining whether a company is a personal services businesses (PSB) are as follows:
- The individual performing the services (or someone related to the person) owns 10% or more of any class of shares of the corporation; and
- Without the use of the corporation, the individual would reasonably be regarded as an employee of the person or partnership paying a fee to the corporation.
The issue of whether someone is an incorporated employee is a question of fact, and must be reviewed on a case-by-case basis. However, answering yes to the following questions would be indicative of an “incorporated employee” relationship with a client:
- Do you have few clients, or worse, one client?
- If you have only one or two clients, do you carry on the duties at that client’s offices on a regular and continuous basis?
- Does your client provide an office and tools of the trade such as a computer?
- Do you have a business card in the name of your client?
- Does the client pay you on a regular basis, without the submission of an invoice?
- Is your name on the client phone directory?
- Would you appear to be an officer or employee of the client to a third party?
- Are you remunerated on an hourly fees basis irrespective of the time needed to accomplish the task?
- Were you hired to perform ongoing services as opposed to completing specific projects?
- Are there expected hours of work that are to be put in each day?
- Must all services be performed by you (that is, would the client not allow you to provide a substitute or not allow you to subcontract your duties)?
- If supplies or equipment are needed to complete a task, are they provided by the client?
- Will the client absorb any risk should a project go over budget?
What are the implications of being a PSB?
- No small business deduction;
- Other deductions limited to remuneration and benefits of the incorporated employee; and
- No general rate reduction (effective for tax years beginning after October 31, 2011).
Clearly this will significantly increase the corporation tax payable. Also, the CRA may decide to reassess multiple years on this basis with a tax rate of 50% or more and may also issue gross negligence penalties.
What should I do next?
If you are considering incorporating your consulting business, then please contact us to discuss your personal situation. It may be more tax efficient to remain as a sole proprietor or to be an employee.
If you are already incorporated and think that you may fall into the PSB category, then please contact us to discuss your situation. It may be sufficient to reword your contract to mitigate the risk of being assessed as a PSB by the CRA, or if this is not possible, then it may be necessary to amend past corporate tax returns accordingly. Either way, our specialists can offer assistance and advice to allow you to make an informed decision.
AG TAX LLP Can Help
If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
- 416-238-5920 (Greater Toronto Area, ON)
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Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.