What are the Implications of Being Declared a Personal Services Business?Brian Jang ON August 22, 2019
Today, more and more single-person businesses are arising, with many of them incorporating for the purpose of liability protection and tax advantages. Unfortunately, some contractors have discovered that the Canadian Revenue Agency (CRA) has declared them to be personal service businesses, resulting in lost tax deductions. Even worse, some may find themselves with a sizable tax bill as they are held responsible for the tax deductions of previous years being disallowed.
Reasons Why You Don’t Want a Personal Services Business
The primary issue with personal service businesses is that the CRA does not view your income as active business income. This results in three tax problems for you:
- You cannot claim the Small Business deduction.
This deduction can only be applied to small business income, which means that you will not have the first $500,000 of your corporation’s income taxed at a lower rate. Instead, it will now be taxed at the personal rate, which is considerably higher.
- You cannot claim many standard business deductions.
Being a shareholder in a business viewed as a personal services corporation, you will be considered an incorporated employee, and not a self-employed individual. This means that you will no longer be able to write off most of your expenses, such as legal fees or accounting fees, supplies, and office space. The only deductions that your corporation will remain eligible for are the salary and benefits paid to incorporated employees.
- Reassessment and Possible Penalties.
Probably the worst news of all, your corporation may be hit with a large tax bill due to claiming the Small Business Deduction and business expenses when you are now considered not eligible for them.
Additionally, the CRA is not limited to auditing only the previous year; there is no limit on the audit process, meaning that during an audit, the CRA can examine records going back several years.
Avoiding Being Labelled as a Personal Services Corporation
One way to avoid being judged as a personal services business is to have more than five full-time employees throughout the year, and/ or ensure that you only provide your services to an associated corporation. These two things are viewed by the CRA as proof that a small corporation is not a personal services business.
Unfortunately, this is not a realistic option for many small corporations. There are some other options, however:
First, avoid working for only a single client, especially over the long term, you will fare much better by having multiple clients. In fact, the more, the better.
While you may not be able to manage five employees, having any employees at all does help, and is a factor considered by the CRA when they determine a small corporation’s status.
There are also four factors used by the CRA to determine if an individual is an employee or an independent contractor. They pay close attention to:
- how much control the contractor has over the work being done
- the ownership of tools
- how much chance of profit or risk of loss that the contractor faces
- the degree of integration
You will want to avoid the perception of being an employee of a client. In general, if a third party might mistake you as an employee of the company, there is a good chance that the CRA could do the same.
With that in mind, there are some seemingly little things that can influence that perception. To protect yourself, you should:
- Make sure you have a written contract with your client, clearly detailing the services you will provide and the specifics of your business relationship. You may find it necessary to consult a lawyer.
- Invoice your client. This can be done either monthly, or with each project. Do not have your client pay you without your first having submitted an invoice.
You don’t need to panic if you are a contractor providing services primarily to a single company, but do make yourself familiar with the potential issues, especially the CRA’s distinction between an employee and an independent contractor. Do what you can to broaden your company’s horizons so that you may protect your corporate status.