Personal Services Business (PSB) is Bad News. Financial Disaster Awaits Those Who are Affected!
It may seem to be a great idea to have a small corporation that you use to earn your income:
- You may be a current employee, but your co-workers have all ceased being employees and instead incorporated their earnings and are deducting lots of expenses. You may be tempted to incorporate to pay less tax.
- You may be in an industry that prefers to hire independent contractors who are incorporated instead of employees. You may be forced to incorporate to find work.
- You may even think that you are truly an “independent contractor” as you have no previous dealings with your customer. But the facts and circumstances of the relationship with your customer may indicate that you are an employee “in fact” and you blindly proceed with your corporation not being aware of the risks.
Basically, a PSB is an “incorporated employee”. If, in the eyes of CRA, you meet the test of being an “employee” rather than an “independent contractor”, then you are caught by the rules.
CRA has issued a policy document outlining their position on “employee vs. independent contractor”. Rather than provide with a link, do a Google search for “CRA Employee or Self-employed?” and that will direct you to the document.
The Courts have introduced several generalized tests which can be summarized as follows:
- Control. The ability, authority, or right of a payer to exercise control over a worker concerning the manner in which the work is done and what work will be done.
- Tools and Equipment. Does the worker provide his own tools and equipment to accomplish the work?
- Financial Risk. Does the worker assume a degree of financial risk?
- Opportunity for Profit. Does the worker have a risk of both profit and loss?
If CRA and ultimately the Courts determine you are an “employee”, then your corporation is deemed a PSB. Once that happens, the financial consequences are as follows:
- There is no Small Business Deduction for the corporation. Instead of the first $500,000 of business income being taxed at the low rate, the corporation pays a higher tax rate which would approach 50%.
- There is no deduction for standard business expenses other than a salary paid to (not just accrued) the owner. All other expenses are denied and added to taxable income.
- If you pay yourself dividends instead of salaries from the corporation, then there is a likelihood of double taxation. Full corporate tax on all the revenue with no deduction for any expenses and the dividend already paid to you will stand with no reversal.
- Penalties and interest on unpaid taxes.
- CRA would normally go back 3 tax years and apply the above rules to each year.
The above, in a worst-case scenario, may result in almost ALL of your gross revenue will become taxes with nothing left for you to take home. This burden may easily bankrupt some taxpayers. As a result, we recommend that you consider the risks and speak with us if you have questions or want an analysis of your situation. In our practice, we always consider these risks for our clients. However, circumstances may change that we may not be aware of and therefore it may be worth having a conversation with us.
ROMANOVSKY & ASSOCIATES LLP
CHARTERED PROFESSIONAL ACCOUNTANTS
Keith M.J. Anderson* BCom, CPA, CA-IT, CITP
Chartered Professional Accountant and Chartered Accountant (Canada)
CA-Designated Information Technology Specialist (Canada)
Certified Information Technology Professional (US)
* Professional Corporation