Tax Tip Thursday

Personal Services Business

This week we are discussing Personal Services Business. This is a very important discussion for many people who own a corporation, but only have one or two clients. I will unravel the details below, but make sure you pay close attention if this situation applies to you! If you are classified as a Personal Services Business (PSB), the corporate tax rate goes from 12.2% to 44.5%!

What is considered a PSB?

Generally speaking, a personal services business exists where the individual would be considered to be an employee of the payer if it were not for the existence of the corporation. This structure is sometimes referred to as an incorporated employee.

If you are a business with under 5 employees, or a business whose revenue comes from a single client, you are at the greatest risk for this classification. If classified under this group, you could lose many of the tax benefits you would have as an incorporated individual. The CRA has re-designated many IT consulting companies as personal service businesses in recent years.

Today, many IT consultants have incorporated their own company to benefit from the tax advantages that come with this status or because they were told they needed too. When a well-paid IT consultant opens their own company, incorporates it and begins working for their former employer, this is a red flag for the CRA.

If this were the extent of the tax implications, that would be frightening enough. However, a reclassification to a personal services business by CRA can cause much greater damage. In some cases, auditors have reassessed individuals for past years as well. A reassessment covering multiple years could lead to tax bills in the hundreds of thousands of dollars.

If you are found on the wrong side of the classification, you are also very limited in terms of what deductions you may have. So, thinking that you can run up your expenses, will not work either. They cannot deduct common expenses including, but not limited to:

  • office supplies,
  • travel expenses,
  • meals, or
  • cell phone costs.

The only expenses a PSB can deduct include the following:

  • any salary, wages, benefit, or allowance the corporation pays to its incorporated employee(s); and
  • legal expenses the corporation incurs for collecting amounts owing.

There are a few things that you can do to help improve your chances of NOT being classified as a PSB.

1. Have a proper contract

  • Written contracts have been given significant importance by Tax Court judges.
  • You should have your own lawyer review the written contract, and you should use a lawyer experienced with the tax issues involved.

2. Work relationship conduct must support the contract

  • The actual working relationship experience must not contradict any of the written contract terms.
  • Ensure that there are many significant working relationship differences between yourself and the employees of your client.

3. Limit the contract length

  • Limit written contract terms to a maximum of 6-12 months and consider avoiding multi-year renewals/relationships with the same client.

4. Diversify your client base

  • Consider avoiding always having one client be 100% of your revenue, i.e., even some part-time clients that account for 10% to 20% of your revenue is preferable.
  • It also makes good business/economic sense to always have more than one client/revenue source.

5. Control your work

  • Although the client can specify results and deadlines, you should control the method and manner of work to achieve those results.
  • E.g., If you hire a painter to paint your house, you would provide the deadline and the colour choice and they would determine the process.

6. Get liability insurance

  • It’s important to assess your risk and consider coverage because, as an independent, you don’t have the financial resources of a big company to back you up in the event of a client lawsuit.

7. Build a professional profile

  • Websites are not limited to small and large corporations. They prove beneficial for contractors / freelancers alike as they serve as a method of promotion for who you are and the services you offer.
  • Have your own business cards and avoid having a business card with the client’s name on it and avoid appearing on the client’s internal telephone list.
  • This makes you look like more of an integrated part of the company and less like an outside consultant or contractor.

8. Your company’s name should reflect your services

  • Ask yourself when you last did business with a company named 123456 Ontario Ltd. Name your company appropriately.
  • Numbered companies are good for holding companies not for operating companies.

9. Hire experienced professionals to represent you

  • If you do not understand the language and implications of the personal service business (PSB) risk, it is very easy to expose yourself to risk.

How to be really sure that you’re not classified as a PSB:

  1. Pay out all income as income to yourself or others working for you in your company.  While this doesn’t change the classification of the corporation, it means there is no income left to tax.
  2. Have 5 plus employees
  3. Have AT LEAST 2 clients, but the more you have the better your odds.

Does this apply to you?

I provided lots of great advice up above that you should definitely consider but hiring a professional here is definitely the right move. Remember point #9? The best way to limit your exposure to this risk is to hire a professional! We can help. Call us today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.