Tax Implications of Personal Services Businesses (PSB) Status & Strategies to Avoid It
Published:
October 23, 2015
Author(s):
- Bruce Russell, former lawyer at McInnes Cooper
- Karen Stilwell, former lawyer at McInnes Cooper
Incorporation offers legal advantages to sole proprietors of small businesses, including certain tax advantages. However, when a corporation carries on a “personal services business” (or “PSB”) as defined in the Income Tax Act (ITA), the corporation will no longer be eligible to enjoy the preferential tax treatment otherwise available to corporations.
“Personal Services Business” Defined. Subsection 125(7) of the ITA defines a PSB as a business of providing services carried on by a corporation where (a) an individual who performs services on behalf of the corporation (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 employee of the entity to which services were provided, but for the existence of the corporation – unless:
- the corporation employs more than 5 full-time employees throughout the year; or
- the amount paid or payable to the corporation for the services is received or receivable from a corporation with which the corporation was associated in the year.
Income Tax Consequences. It’s important to be aware of the PSB rules because the ITA denies corporations that carry on PSBs certain forms of preferential tax treatment otherwise available to corporations, and additional liabilities could be imposed, including the following:
- Small Business Deduction. Denial of the small business deduction (see ITA, Subsection 123.4(1), paragraph (a)(iii) of the definition of “full rate taxable income”)
- Business Expense Deduction. Denial of business expense deductions, other than the very limited deductions allowed to employees (see ITA, paragraph 18(1)(p))
- Source Deductions & Remittances. Imposition of Canada Pension Plan and Employment Insurance withholding and payment obligations on the remuneration paid to the “incorporated employee”
Strategies to Avoid PSB Status. There are two key strategies a corporation may employ to avoid characterization as a PSB under the ITA:
- Employ “More Than 5” Full-Time Employees. A corporation that otherwise meets the definition of a PSB under the ITA, but employs more than 5 full-time employees, is not a PSB for income tax purposes.
- “More than five”. The “more than five” criterion is satisfied by 5 full-time employees plus a part-time employee (see: 489599 BC Ltd., 2008 CarswellNat 1717 (TCC)).
- Year Round. To avoid PSB status, the corporation must meet the minimum employee threshold throughout the year.
- Avoid Indicia of Employment Relationships. A second strategy is to avoid unintentionally creating an “employment-like” relationship between the “specified shareholder” and the client.
- Employee v. Independent Contractor. The issue of whether a person is an employee or an independent contractor is among the most frequently litigated tax issues in Canada. As a result, there is a significant number of Tax Court of Canada and Federal Court of Appeal decisions providing guidance on the distinguishing factors.
- Indicia. The test for the existence of an employment relationship can be summed up with this question: “Whose business is it?” The indicia of an employment versus independent contractor relationship are well-settled by court decisions (see: Wiebe Door Services Ltd. v. MNR (1986) 2 CTC 200 (FCA); 1392644 Ontario Inc. (Connor Homes) v. Canada (National Revenue), 2013 FCA 85): Who owns the tools? Who controls the service provider? Does shareholder enjoy chance of profit? Does shareholder bear risk of loss?
- Parties’ Subjective Intention Irrelevant. The subjective intention of the parties to avoid creating employment-like relationship is irrelevant in context of evaluating whether a corporation carries on a PSB. See, for example:
- 1166787 Ontario Limited v. Her Majesty the Queen, 2008 TCC 93
- 609309 Alberta Ltd v. Her Majesty the Queen, 2010 TCC 166
- Gomez Consulting Ltd. V. Her Majesty the Queen, 2013 TCC 135
- G&J Muirhead Holdings Ltd v. Her Majesty the Queen, 2014 TCC 49 [Informal Procedure]
Please contact your McInnes Cooper lawyer or any member of our McInnes Cooper Tax Solutions Team to discuss this topic or any other legal issue
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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