If you are an IT consultant or work on a contract basis, you should be aware that in October 2012, the government increased the tax rates for personal services corporations by 13%!
This change in the tax rate and the recent focus on IT contractors by the CRA can have a dramatic effect on your business if you fall into the personal services category.
Understanding The Tax Impact
The tax rate for most Canadian small businesses in Ontario is 15.5%. If you are considered a personal services business then you can expect the following:
- Most of your expenses will be denied,
- You will be denied the small business deduction, and
- You will be denied the general rate reduction.
The result is that your basic tax will increase to a flat 39.5%. And when you pay those out in dividends, the combined tax rate can approach 58%!
What is a Personal Services Corporation?
A personal services corporation is a corporation where a specified shareholder (normally you or your spouse) perform services to another business and you would normally be considered an employee of the hiring firm if it weren’t for the corporation.
How Do You Define A Personal Services Corporation?
There are four factors that will be considered when evaluating if you are a personal services corporation:
Control
Consider that an employee is generally under the supervision of management of the hiring company and the he or she must commit to a certain number of hours. On the other hand an independent contractor is free to organize their day and is independent from the company.
Integration
Is the work performed an integral part of the business? For example, an independent contractor may be hired to install a system or component in a hiring firms facility. The contractor is performing a one-time job for a specific purpose and after the work is done, the contractor has no further obligations.
On the other hand, if the work being performed is integrated with the operations, to the extent that the work performed would be a continuous function, then this would lean towards being an employee.
Economic Considerations
Who has the business risk, legal liability and responsibility for expenses?
If you provide the tools and equipment, must cover your own business overhead and have legal liability or contractual liability, you may be self-employed. On the other hand if the hiring firm assumes the risk then you are an employee.
Results
If you are hired for a specific purpose and objective as opposed to committing only to a time-frame, then you may be considered self-employed.
What Can You Do?
If you feel you may be considered a personal services business, you may go back and renegotiate your contract to have it provide enough autonomy and control to classify you as a business.
You should meet with your accountant to discuss these matters and determine if there are other strategies you can use to avoid these rules.
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{ 6 comments }
Hi TaxGuy,
I am self employed with only two clients currently.
Gross annual income average is 100,000.00 for the last five years. Service only, no product sale the last two years. Is it woth incorporating the business?
It depends on the facts of your case. We would need to look each of the situations and determine whether you would be considered an employee or self-employed.
If you are considered an employee, based on the facts, then your employer may be required to withhold tax and remit CPP (even without a corporation).
I an an IT contractor for the last 20 years. I incorporated 13 years ago. I have worked for dozens of clients over that time frame. I currently have 3 clients but one of those clients makes up 85% of my revenue – the others are only short term projects a couple of times per year. I work at my home office and go into the client offices 1 day per month. I provide my own equipment. I set my own schedules. My contract clearly states fixed price work and I bear all the risks of overages.
Should I be concerned about being classified as a PSB?
We would have to look at all of the factors around the one client that makes 85% of your revenue to determine if that arrangement could be considered an employment compared to business. If the factors are substantively present, then you could be considered a PSB.
If you are classified a Personal Services Business by the CRA, but your business operations change in the future enough that you would no longer be considered an incorporated employee, how would you go about having the PSB designation removed?
Hi Danielle,
The characterization of PSB is on the source of income itself and if the nature changes you would simply file the tax return reporting it accordingly.
Of course, there may be questions from the CRA and you should be able to substantiate the claim. The assistance of a professional accountant with experience in these matters is helpful.