What you need to know about the Personal Services Business designation

It’s not very well-known, but it could potentially be quite damaging.

If you’re a one-person business, you could be at risk of losing tax advantages under the Personal Services Business designation. It’s not very well-known, but it could potentially be quite damaging.

We look at how you can make sure your business is protected from this tax issue.

Protecting your business

If you’re supplying services as an independent contractor, consultant or project manager through a small corporation, it may be worth your while to learn more about the issues surrounding Personal Services Business (PSB) designations.

PSB (also known as Personal Services Corporation or ‘Incorporated Employee’) designations can affect people who perform job-like services through a corporation they (or family) primarily own.

What’s the risk? If you are deemed to be a PSB, the Canada Revenue Agency (CRA) could disallow your eligibility under the Small Business Deduction and you may lose all of the associated financial benefits.

Under the Small Business Deduction, corporations earning less than $500,000 might pay as little as 15.5% in taxes, whereas an employee might pay 43% or more in taxes.

History of PSB

CRA’s original concern involved situations where a well-paid employee of a business decides to quit their job, form a small corporation, and sell the same services back to the former employer – thereby benefiting from the lower tax rates levied to businesses.

What are the consequences of being deemed a PSB?

There are several issues to watch, suggests one expert.

“Losing the Small Business Deduction could mean you’ll be reassessed as an employee and presented with a huge tax bill,” warns Andrew Wall, Vice-President of CA4IT, a national accounting firm specializing in protecting entrepreneurs from PSB attacks.

Wall says it gets worse. “An incorporated small business enjoys the ability to lower its taxable income by distributing revenue to family members in the form of salaries or dividends. As a PSB, you’ll lose those options to split income.”

Corporations are entitled to deduct a fairly broad variety of business expenses in the pursuit of income. “Every business owner rightfully deducts standard business expenses such as business telephone, client meals, insurance and travel,” states Wall. “Under a PSB designation, those receipts are disallowed.”

What are the main criteria for PSB designation?

Wall says it all comes down to interpretation. “CRA will try to determine that, absent the corporation, the individual could reasonably be regarded as an employee of the customer.”

He explains that CRA will consider factors pertaining to “control, conduct and contract” when assessing whether a business owner should be deemed ‘self-employed’ or ‘employed.’

CRA typically assesses each case based on a suite of qualifying criteria, including:

  • A small number of clients. Working with only one client looks suspicious because it creates the appearance you are really an employee.
  • Performing services at client offices on a regular basis rather than your own professional space.
  • Using the office equipment and tools supplied by your client instead of your own.
  • A business card in the name of your client.
  • Appearing to a third party as someone who works directly for the client.
  • An expectation from the client that you will personally perform the work.
  • The number of employees you have.

How to avoid PSB designation

There are preventative measures you can take to minimize your exposure. For starters, study more on this important subject. “Learn how CRA defines PSBs so you can make sure your business is disqualified,” recommends Wall. “And, of course, consult a qualified tax specialist such as an accountant with experience in PSB issues.”

Wall offers one final piece of advice. “Small business owners can get themselves into trouble by attempting to answer CRA questions concerning PSB criteria before speaking with a tax specialist,” stresses Wall.

That’s why it may be best to defer that conversation to a qualified tax specialist who can answer CRA on your behalf.

(Disclaimer: As this article only presents information about the Personal Services Business issue, always consult a qualified tax specialist about your particular exposure and risk.)

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