Many self-employed individuals are personal service providers, and often there is confusion about the tax treatment of their business. A question that is frequent amongst the corporate clients of AG Tax is whether their business will be subject to either corporate tax or personal services business tax. Given the frequency of this question, our tax practitioners have prepared a brief overview on personal service business taxation in Canada. Remember, it is always recommended to consult your personal tax advisory for tax recommendations based on your personal tax situation.
Personal Services Business/Corporation as per the CRA
According to the Canada Revenue Agency (CRA) a personal services business is a corporation that provides services performed by individuals for the corporation, or a person related to the individual providing the services is a shareholder of the corporation, providing services to another entity provided there are not more than 5 employees working for the company, and providing personal service during a tax year.
If the individual providing the services is a contractor and not an employee, it will not be as likely that the corporation will be considered as a personal services business by the CRA.
It is very common for IT and other business consultants to be considered as running a personal services business.
Tax Rate for Personal Services Business
Since personal services business income is not considered active income by the CRA, it does not qualify for deductions such as the small business deduction which is only available if the business is earning ‘active income’.
Additionally, the income from a personal services business is taxed at a personal business tax rate which is quite high (20% to 58% depending on the province). The business may also not qualify to claim various business expenses as deductions (such as bad debts, bank charges, interest or insurance expenses, or any other general/common business expense).
It is no wonder a common practice amongst personal services business owners is to consult tax professionals and develop strategies to ensure their business is not classified as a personal services business. If designated by the CRA as a personal services business, the corporation could end up incurring significant tax expenses as the CRA could reassess past years’ tax filings as if the corporation were a personal services business in those years. This would result in the corporation paying a substantial amount of additional taxes based on the reclassification.[i]
Deductions Claimable by a Personal Services Business/Corporation
A personal services business can only claim the salary/wages paid to its employees performing the services, or the cost of any benefits provided to the employee as a business expense. such as: insurance premiums, etc., or at times any expense incurred in selling a property or negotiating a contract or any legal expenses incurred to collect amounts for services rendered.
What to Keep in Mind When Starting a Personal Services Corporation/ Business
The CRA has quite a few points to determine whether a corporation is a personal services corporation or business. Keeping these factors in mind while forming your company can help you avoid being classified as a ‘Personal Services Business’ by the CRA.
- Firstly, keep the employee count higher than five for the tax year;
- And, although everybody prefers having a set of fixed clients, avoid catering to a few common clients on a regular basis. As much as possible try to provide services to more than one or two long-term clients.
- Always issue an invoice or bill to your clients, which will show that you are a separate service provider and not an employee of the company (client). It is necessary that the corporation should not look like it is employed by a particular corporation (client).
- Keep a check over the revenue generated by the business. How the profits are distributed amongst employees and how they are maintained as a reserve for the corporation.
The above points are a few basics that are easily controllable by the owner, and could help prevent the CRA from reclassifying your corporation.
However, as a safe practice it is highly recommended to consult a tax advisor/lawyer before proceeding with such tax measures as each tax situation varies, and proper tax advice can only be provided based on one’s unique tax situation.
AG Tax LLP Can Help
Tax situations can be very complicated, especially if there are minor changes in circumstances which could potentially have severe impact on one’s taxes.
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide with 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., Canadian, and other international tax laws.
We can assist with:
• Canadian Personal and Corporate tax returns
• Cross Border Taxation and Business Planning
• U.S. Personal and Corporate Taxation
• Disclosure of Foreign Assets and other information filings
• Retirement planning
• Estate Planning, Inheritance tax advice
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.