Are You Operating a “Personal Services Business”? Here is What You Need to Know
Many Canadians incorporate their businesses to take advantage of tax deferrals and the Small Business Deduction. However, if you incorporated your business primarily to provide services to just one other company, the Canada Revenue Agency (CRA) might consider you a Personal Services Business (PSB).
This distinction is crucial because being classified as a PSB significantly changes your tax obligations and eliminates many of the tax benefits usually associated with having a corporation.
What is a Personal Services Business?
Generally, a PSB exists when the individual performing the work would be considered an employee of the hiring company if the corporation did not exist. This is often referred to as being an “incorporated employee.”
The Financial Risks: Why Classification Matters
If your corporation is deemed a PSB, the tax implications are severe. Unlike a regular active business, a PSB faces higher tax rates and fewer privileges.
A PSB is subject to:
- The full federal and provincial corporate tax rates.
- An additional 5% tax on PSB income.
A PSB is NOT eligible to:
- Claim the Small Business Deduction (which significantly lowers tax rates for most small businesses).
- Claim the General Tax Rate Deduction.
Expense Restrictions
One of the biggest advantages of a corporation is the ability to deduct business expenses. However, PSBs are restricted here as well. A PSB cannot deduct all expenses. Deductions are generally limited to the salary and wages paid to the incorporated employee and very few other specific costs.
Your Obligations as a PSB
Even if you are classified as a PSB, you must still maintain compliance with the CRA. A PSB is responsible for:
- Filing a Corporation Income Tax Return (T2).
- Issuing T4 slip(s) to its employee(s).
- Filing GST/HST returns.
Quick Self-Assessment: Are you a PSB?
If you are unsure if these rules apply to you, review this quick checklist based on CRA guidelines. If you answer “YES” to the following, you are at high risk:
-
☑ Do you work for only one client?
If you have incorporated to provide services to primarily one other company, you are a target for PSB classification. -
☑ Are you an “Incorporated Employee”?
Would you be considered an employee of the hiring company if your corporation did not exist? Generally, this means the client controls how, where, and when you do your work. -
☑ Do you perform the work personally?
Is the incorporated individual the one physically performing the services for the client?
Result: If you checked these boxes, you may be subject to the additional 5% tax and expense restrictions. Please contact us immediately.
The CRA is Watching: The PSB Pilot
In 2022, the CRA launched a pilot project to analyze PSB business practices and education. Phase 2 of this pilot, which ran from October 2023 to Fall 2024, focused on identifying potential PSBs and educating them on their filing obligations. The results of this pilot will determine future CRA engagement activities.
Next Steps
If you are unsure if your business relationship puts you in the PSB category, it is vital to review your situation immediately. The rules regarding “employee vs. independent contractor” are complex.
Contact our office today to review your corporate structure and ensure you are compliant with CRA regulations.
