Post by: Cory Lefebvre, CPA, Associate

A personal services business (PSB) exists where the individual performing the work would be considered to be an employee of the payer if it were not for the existence of the corporation. A corporation may be a PSB if the following criteria are met:

• the incorporated employee performing services owns at least 10% of the issued shares of any class of the corporation providing the services.
• if the corporation did not exist, you would be considered an employee of the entity receiving the services.
• your corporation does not employ more than 5 full-time employees throughout the tax year, and the amounts received by your corporation for services were not received from a related secondary corporation.

Tax Implications for Personal Service Businesses and its Owner:

• Loss of eligibility for tax deductions: PSBs are not eligible for the small business deduction, which provides a lower corporate tax rate on the first $500,000 of active business income. There is also no access to the general rate reduction of 13% and an additional 5% tax penalty. In Alberta, if the corporation is classified as a PSB, the tax rate would be 41% compared to 11% for a similar corporation not classified as a PSB.
• No Access to the Lifetime Capital Gains Exemption: PSBs do not have access to the Lifetime Capital Gains Exemption, which allows individuals to shield a portion of their capital gains from taxation upon the sale of qualifying assets.
• Non-Deductibility of Certain Expenses: the only eligible expenses allowed for PSBs are salary and wages paid to incorporated employees, benefits or allowances provided to incorporated employees, expenses associated with selling property or negotiation contracts, legal expenses incurred to collect amounts owing. Common business deductions such as travel, professional fees, tax depreciation of capital assets, or fuel are all not eligible deductions for a PSB.

Risk Mitigation Strategies:

• Diversify Client Base: avoid over-reliance on a single client, as this can trigger PSB classification.
• Document contracting relationship with corporate customer: an employment relationship with your customer causes as PSB classification. Properly document the relationship with the contracting customer and ensure you use your own equipment, have control over your work and schedule, work independently with no close supervision, hire your own employees or subcontractors, and invoice your customer for services provided.
• Provide Goods Alongside Services: offering goods alongside your services can help demonstrate that your business is not purely a personal service business.
• Remuneration Planning: carefully plan how you pay yourself, balancing salary and dividends to optimize your tax position. Salary is the preferrable option for companies at risk as salaries are an eligible deduction for PSBs.
• Focus on Growth and Expansion: invest in expanding your business, hire employees, and take on multiple projects. This can help prove that your business is not solely dependent on your personal skills.

Conclusion:

Operating a personal service business in Canada comes with unique tax implications and potential risks due to the distinct tax treatment. To mitigate these risks, it’s essential to diversify your client base, document your relationship, consider offering goods alongside services, manage your compensation wisely, and focus on business growth.  Feel free to contact our office if you have any questions about personal service businesses or feel you may be at risk.