There is a lot of talk as to whether a corporation is deemed to be a personal services business corporation (“PSB”) or not, and its implications.
First, let’s have a look at the interpretation of what constitutes a PSB. The income tax act carries the following definition in 125(7):
“personal services business” carried on by a corporation in a taxation year means a business of providing services where:
(a) an individual who performs services on behalf of the corporation (in this definition and paragraph 18(1)(p) referred to as an “incorporated employee”), or
(b) any person related to the incorporated employee is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless the corporation employs in the business throughout the year more than five full-time employees, or
(d) the amount paid or payable to the corporation in the year for the services is received or receivable by it from a corporation with which it was associated in the year;”
Let’s have a look at the exemptions that exist:
1) More than 5 full time employees – the CRA accepted the view that this test is met when a company employees 5 full time employees and 1 or 2 more part time employees according to TN-41 December 23, 2009, following the 489599 BC Ltd v The Queen ruling.
2) Associated corporation – If the corporation employees a person that is deemed to be an incorporated employee, and the corporation meets the association rules, with respect to the corporation to which the services are rendered, then the corporation will not be treated as a personal services business.
If you do not meet either of the above exemptions, then the following is the criteria the CRA generally uses to identify whether a corporation is deemed to be a PSB or not:
-The level of control the employer or hirer has over the worker’s activities – if the employer dictates hours worked, location of work, and items of this nature, then the business will most likely be deemed a PSB
-Whether the worker provides his or her own equipment – this test generally refers to both tools and expertise. If the employer provides the equipment, space, and technical know how than a business will most likely be deemed a PSB
-Whether the worker hires his or her own helpers – If the employer can sanction who the worker can hire, and if they can be hired then the business will most likely be deemed a PSB
-The degree of financial risk taken by the worker – this is probably best illustrated with an example. A company provides IT services to a single client. In one case, the company charges the client for each hour worked charged at a pre-determined rate, and in another case, it pays for a deliverable. In the first instance, there is no risk as regardless of the number of hours spent for the client or whether anything is delivered, the company will get paid. In the second instance, the company will only get paid if it delivers the deliverable at a specified time, and regardless of the effort spent. Accordingly, in the first instance arguing risk is far more difficult than in the latter case.
-The degree of responsibility for investment and management undertaken by the worker
-The worker’s opportunity for profit (or risk of loss) in the performance of his or her tasks; and
-The intention of the parties, as expressed in the relevant documentation and by their actions.
If you examine the above criteria and believe that even one would indicate that the corporation is a PSB, then that is most likely the same view that the CRA will take.
Let’s examine the rationale behind someone wanting to run a PSB, and whether it does in fact negate some of the consequences:
1) Ability to deduct expenses such as a home office and car. As an employee, if your employer requires you to maintain a home office, and to travel, then your employer will provide you with a T2200, which will allow you to claim home office expenses, and car expenses. Therefore, this is only beneficial, where your employer would not require you to work from home, and accordingly, you are not entitled to car expenses resulting from commuting from home to your normal place of work.
2) Ability to defer income – if you make substantially more than you would being employed, and you do not need to have access to all the funds, than you can defer income through a PSB, which you cannot do as an employee. However, you should note that the deferral most likely only works in the first year of operations. Let me illustrate why it only works in the first year:
Let’s assume that your business earns $200,000 in each year, and that you pay yourself $120,000 per year, with a bonus of $40,000 per year, payable within 180 days of your corporation’s year end. Let’s assume you set up your business in 2025, and that you won’t have any clients in 2029.
Your taxes would be computed as follows in 2025:
Corporation income:
Income $200,000
Salary (120,000)
Bonus (40,000)
Taxable corporate income $40,000
Personal income $120,000
In years 2026-2028, the following would occur:
Corporation income:
Income $200,000
Salary (120,000)
Bonus (40,000)
Taxable corporate income $40,000
Personal income $120,000
add: bonus 40,000
Total personal taxable income $160,000
2029 income calculation:
Corporation income – $0
Personal income – $0
Add: bonus 40,000
Total personal taxable income $40,000
Hence the deferral is only good for the first year, and eliminates itself once your business stops generating income.
3) Ability to income split – you can split your income with your spouse and/or children, however, the income you pay them has to be deemed reasonable for the services rendered by the CRA or they can deny the entire expense.
4) Ability to pay eligible dividends – seeing as a PSB is not entitled to the small business deduction, and pays tax at the regular tax rate, any dividends paid will attract a lower rate of tax as they will qualify for eligible dividend treatment. To maximize the potential, your spouse, and/or children should subscribe to shares of your corporation, assuming they are in a lower tax bracket, and are able to purchase the shares with their own cash, for the attribution rules not to apply, and that there are no kiddie tax implications.
After reviewing the advantages and disadvantages of a PSB, the following are the tax consequences of a PSB:
1) As previously mentioned, a PSB is not entitled to the small business deduction
2) The tax rate on corporations deemed to be PSBs is 33% federally. As such, the corporate tax rate in Ontario is 44.5%, making having a PSB highly undesirable, as there is no integration of taxes.
Should you have any questions, concerns, or need help dealing with your tax situation please contact us.
