What is a Personal Services Business?Brian Jang ON December 7, 2018
The number of people working from home has been growing steadily over the past few years and is expected to continue growing as we move into the future. As these single-person small businesses develop, their owners look to any advantages they can in order to turn a profit, save on taxes, and more.
One popular method that these small businesses take is to incorporate, for both liability protection and tax advantages. Some of them are finding out, however, that they may lose most of their tax deductions in the event they are declared to be a personal service business. More than that, they may also be accountable for a sizable tax bill to recover the now-disallowed deductions from previous years. So, what precisely is a personal services business?
A personal services business is defined as:
“… a business that a corporation carries on to provide services to another entity (such as a person or a partnership) that an officer or employee of that entity would usually perform”(T4012 –T2 Corporation Income Tax Guide, Chapter 4, Canada Revenue Agency).
The reason that this is undesirable is that income from a personal services business is not viewed by the CRA as active business income. This results three new tax problems for you:
- You will no longer be eligible for the Small Business Deduction, given that it can only be applied to active business income. With the Small Business Deduction, you are able to have the first $500.000 of your corporation’s income taxed at a significantly reduced rate. Without that deduction, you will be taxed at the personal rate.
- You will lose many standard business deductions. If your business is declared a personal services corporation, you will not be considered to be self-employed, but rather you will be an incorporated employee. As such, you will no longer be able to claim expenses such as accounting or legal fees, supplies, or your office space. The only deduction that will be eligible for your corporation is the salary and benefits paid to the incorporated employee.
- Potentially the most devastating result of this change is the possible tax penalties arising from reassessment. This could end up being a rather large amount owing because you filed “incorrectly” when you claimed your business expenses and Small Business Deduction. You may find yourself owing back taxes for a period of several years.
What You Can Do to Avoid Being Named a PSC
The obvious way to avoid being deemed a Personal Services Corporation is also not really an option for many small corporations: ensure that your corporation has more than 5 full-time employees throughout the year, and/or provide your services only to an associated business. These are two things that the CRA looks for when deciding that a small corporation is not a personal services business, but you may not be in a position to do this.
Fortunately, there are other options.
One of the most important things you can do is avoid working for a single client, especially in an ongoing, long-term relationship. You have a better chance of avoiding the personal services business designation if you are dealing with multiple clients. You do not want to risk being seen as the employee of a specific client.
Having an employee– even if you do not have the suggested 5– is also helpful and is something that the CRA will consider in determining your status.
There are 4 other issues that will be looked at by the CRA when they assess whether a person is operating as an independent contractor:
- The amount of control over the work that a contractor has
- The degree of integration
- Ownership of tools
- The risk of loss/ chance of profit that the contractor faces
Some other things you should do:
- Ensure that you have a written contract detailing all of the services that you are providing to your client, as well as the nature of your relationship. You may prefer to consult a lawyer for this.
- Invoice your client. You may do so monthly, or per project. You do not want a client paying you without an invoice.
If you are in a position where you are providing your services to one other company, you should take the time to become familiar with the CRA’s definitions of employees and independent contractors. It would also be wise to take what steps you can to protect your corporate status.