Answer
A Personal Services Business (PSB) is a corporation that provides services that would typically be performed by an individual, often referred to as an “incorporated employee.” The Canadian tax rules for PSBs are designed to prevent individuals from incorporating solely to gain tax advantages that would not be available to them as employees. KWB can help you navigate these complex regulations to ensure compliance and avoid potential penalties.
Overview
This guide details the tax implications and compliance requirements for a personal services business PSB in Canada. It covers how the Canada Revenue Agency (CRA) identifies these entities and the specific tax rules that apply, which differ significantly from those for other corporations.
The article also includes a labeled real-world hypothetical about Alex, an IT consultant in Edmonton, Alberta, illustrating how these rules affect a typical professional.
- Defining PSB: Understand the criteria the Canada Revenue Agency uses to determine what constitutes a PSB in Canada.
- Common Questions: Find answers to frequently asked questions regarding PSB tax rules and compliance.
What is a Personal Services Business (PSB) in Canada?
Updated November 2022
Are you a Personal Services Business (PSB)? We often hear about individuals who decide to incorporate while working as an employee for a business. But is it really beneficial to do so?
Let’s look at an example. Joe works as an employee and earns employment income (a T4 slip) in Alberta. On July 1, he incorporates. Although he has incorporated, he continues to work for the same employer in the same role. Instead of being paid personally, income is now earned through his corporation. Joe’s corporation does not have any employees, nor does it perform work for any other customers. Joe’s company would be considered a PSB.
PSB’s can be identified by the following characteristics:
- An incorporated employee
- Provide services
- Has less than five full time employees
- Own 10% or more shares in the incorporated company
- Works for only one customer, where they are regarded as an employee or officer
Joe’s corporation provides the same services that he would perform for his employer, as if he was working as an employee. Therefore his corporation is considered a personal services business.
If the CRA considers you to be a personal services business, your corporate tax rate would increase significantly. This is because the corporation would no longer qualify for the small business deduction. PSB income is subject to the federal corporate tax rate of 28% plus the general provincial corporate tax rate of 8% for a total tax rate of 36% for Alberta companies. That is 19% and 6% higher than the federal and provincial small business rates.
You would also lose the ability to deduct the same expenses that a small business does. Joe’s corporation is now only able to claim the cost of salaries and benefits to him personally, and a few other allowable expenses.
What this means is that there will be a significant tax cost when earning the income in the corporation and paying it out as a dividend compared to earning the same income personally or taken as a salary. Further, there will only be a small tax deferral associated with retaining the income in the corporation for a period of time.
Example of the impact:
Let’s assume that Joe’s corporation earns $ 200,000 per year.
| Small Business | Personal Services Business | |
| Income | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 200,000 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 200,000 |
| Federal tax rate | 10% | 28% |
| Provincial tax rate (AB) | 2% | 12% |
| Corporate tax | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 24,000 | Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 80,000 |
| Net income | 176,000 | 120,000 |
Without the small business deduction or general rate reduction, you can see that the amount of taxes payable significantly increases, leaving less income to grow and invest in your business.
If you think that you might be a PSB and have been claiming the small business deduction, please give us a call to discuss planning opportunities. Finding out that the CRA has surprisingly reassessed you as a PSB would be a very costly event. CRA has the ability to go back and reassess tax returns from previous years as well. This could result in significant penalties and interest, in addition to the taxes owing as a result of the change in tax rate.
Consequently, if you are considered a PSB it would be best to conduct your business as an unincorporated contractor under these new rules. That is not to say that corporations are totally out of luck. If set up as an incorporated company, businesses can still bonus out income to the owner employee so that the income will not be subject to the 36% corporate tax rate, and thereby avoid a significant tax cost.
Another key consideration is that if you are deemed to be a PSB the expenses that you are allowed to deduct in calculating your taxable income are more restrictive than if you are not a PSB.
More Information on Personal Services Businesses
For information on CRA requirements and tax rules for Personal Services Businesses as well as tips for managing risk, click here.
If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.
Thanks to Stephanie Bergeron of KWB for providing much of this content.
FAQ
Navigating the complexities of personal services business (PSB) tax rules can be challenging, so we’ve compiled answers to some of the most common questions to help you better understand this important topic.
| Question | Answer |
|---|---|
| What constitutes a Personal Services Business (PSB) under Canadian tax law? | Under Canadian tax law, a Personal Services Business (PSB) is a corporation where a specified shareholder or a related person provides services that would otherwise be considered employment income. This distinction is critical because it impacts the tax treatment, often resulting in higher corporate tax rates for businesses operating in Edmonton, Alberta. |
| How does the Canada Revenue Agency determine if an incorporated business in Edmonton is a Personal Services Business (PSB)? | The Canada Revenue Agency determines if an incorporated business in Edmonton is a Personal Services Business (PSB) by assessing whether the individual performing the services would be considered an employee of the client, if not for the corporation. Key factors include the degree of control over the work, ownership of tools, and the individual’s opportunity for profit or risk of loss. |
| What are the specific tax consequences for a Personal Services Business (PSB) operating in Edmonton, Alberta? | For a Personal Services Business (PSB) operating in Edmonton, Alberta, the primary tax consequence is ineligibility for the small business deduction. This means PSBs are taxed at a significantly higher corporate rate, often comparable to personal income tax rates for employees. Consequently, PSBs in Edmonton face a greater overall tax liability compared to other small corporations that qualify for the deduction. |
| What options exist for businesses in Edmonton to avoid being classified as a Personal Services Business (PSB)? | Businesses in Edmonton can explore options like diversifying clients, demonstrating control over their work, and ensuring they operate with a chance of profit and risk of loss, rather than solely as an incorporated employee. Consulting with a tax professional in Edmonton is advisable to properly assess your specific situation and strategize to avoid PSB classification. |