It has become quite common for professionals and knowledge workers to set up their own corporation to perform services to one or more corporations. Being incorporated has many advantages: access to the small business deduction and the related low income tax rate, a possible deferral of income tax, limited liability, and potential access to the $800,000 capital gains exemption on qualifying small business corporation shares.
A corporation will generally be considered to earn income as a “personal service business” (“PSB”) where “but for” the existence of the corporation, the shareholder of the corporation would be considered an employee of the company to whom the corporation provides services.
There are special rules that apply to income earned from a PSB.
Is your Corporation a PSB?
To be defined as a PSB corporation, a specific shareholder (owns at least 10% interest in the corporation) is providing services to another business and the individual who is performing the services can reasonably be regarded as an employee of that other business.
When a corporation meets the above criteria, it is no longer eligible for the small business deduction, is subject to full corporate tax rates and is limited on claiming certain business expenses (other than wages or expenses that would normally be deductible for an employee).
The PSB rules apply when an individual derives personal services income which is income mainly from an individual’s personal efforts or skills. However, there are exceptions to this rule. Whether a person is an employee or a self-employed contractor is a question of fact that can only be determined following a complete analysis of the circumstances of a particular situation. Many factors must be taken into consideration in establishing whether there is an employee-employer relationship. Moreover, no one factor, in and of itself, will result in the determination of the relationship. (See Appendix A for a comparison between being a PSB and an Independent Contractor.)
However, answering yes to the following questions would be indicative of being a PSB:
- 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?
- The structure of your business
The Income Tax Implications
The corporation will be prevented from claiming the small business deduction, both federally and provincially, you will no longer even get the general rate reduction. The result is that the combined Federal and B.C. Tax rate will be 39% on income. Also, there are limitations on what expenses can be claimed.
A few things to consider when drafting your contracts
You should consider the following points when drafting your contracts:
- must have agreed to provide a service with no commitment regarding the number of hours worked or work schedule
- should also be performing the service with little or no supervision
- should not receive any benefits
- consider hiring helpers on the projects, include in contract
- travel costs – include on invoices and in contract
- enter into contracts with specific tasks or projects in mind
The Canada Revenue Agency applies the following tests to determine if your contract falls within the PSB corporation:
|Test||Description||Incorporated Employee (PSB)||Independent Contractor|
|Ownership of Tools||
|Chance of profit and risk of loss||
|Degree of integration||
|Degree of control||
NOTE: All facts must be examined to correctly ascertain the true nature of the work relationship.