What characteristics define a Personal Services Business (PSB) in the context of Canadian tax law?

In Canadian tax law, a Personal Services Business (PSB) is defined as a corporation providing services to another entity, where the individual performing those services would otherwise be considered an employee of that entity. This classification is critical because it significantly impacts the corporation's tax obligations.

How does classification as a Personal Services Business affect tax obligations for incorporated employees?

Classification as a personal services business (PSB) significantly impacts tax obligations. PSBs face a higher corporate tax rate and are not eligible for the small business deduction, resulting in less after-tax income for the business.

What are the reasons individuals might elect to operate as a Personal Services Business?

Individuals may operate as a personal services business (PSB) for perceived benefits such as limited liability or to project a professional image. However, the significant tax disadvantages generally outweigh these perceived advantages, making it an unfavorable business structure for most.

What strategies can KWB Accountants & Advisors suggest to avoid Personal Services Business classification?

To avoid personal services business classification, you can implement strategies such as serving multiple clients, incurring significant business expenses, and demonstrating control over your work. These actions help establish your corporation as an independent entity rather than an incorporated employee.

Personal Services Business: What You Need to Know

Discover the implications of operating as a personal services business. Understand the benefits and potential pitfalls of incorporating as an employee.

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 business in the same role.

This situation is known as a “personal service business”. PSB’s can be identified by the following characteristics:

An incorporated employee
Provide services
Have fewer 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

One of the biggest disadvantages if the CRA considers you to be a PSB is that your corporate tax rate would be significantly more, 37% compared to 12% for an Alberta small business. You recapture some of the extra tax cost through lower personal dividend rates, but it will end up costing about 13% on all income that was deemed to be PSB income.

Let’s assume that Joe’s corporation earns $ 500,000 per year. A calculation comparing the two types of corporations is shown below:

Regular PSB

Income 200,000 200,000

Corporate Tax 28,000 76,000

Net Income 172,000 124,000

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.

The deductibility of expenses for a PSB is also limited. Joe would only be able to claim the cost of salaries and benefits, and a few other allowable expenses.

If you think that there is a possibility that you might be a PSB please give us a call to discuss it. Finding out that the CRA has surprisingly reassessed you as a PSB would be a very costly event.

For more detailed information please call KWB at 780-466-6204 or email us by clicking here.