Personal Services Businesses: CRA Rules And Tax Implications

Answer

Personal services businesses (PSBs) face specific tax rules and implications from the Canada Revenue Agency (CRA). Understanding these regulations is crucial to avoid significant tax disadvantages. KWB can help you navigate these complexities and ensure compliance, potentially saving you a substantial amount in taxes.

What Are Personal Services Businesses (PSBs)?

The Canada Revenue Agency (CRA) will be increasing their focus on personal services businesses and assessing for breeches of tax rules, according to an update from CPA Canada on September 6, 2022.

With more Canadians choosing to incorporate their businesses, the CRA will be analyzing if a corporation is operating as a personal services business and what that corporation’s tax situation is. They will be examining the personal services business rules that apply when services are provided through a corporation and if the individual providing the services should be considered an employee.

What Defines a Personal Services Business (PSB) in Canada?

Individuals who provide services to businesses and who are incorporated may be considered personal services businesses. It is common practice for hiring companies to require individuals to incorporate to limit liability in industries such as trucking, IT, accounting, construction, and catering.

However, if you register yourself as a corporation to perform services for a hiring business and they are the only or primary source of revenue for your corporation, you may be considered to be operating a personal services business.

Scenario: Determining PSB Status for Contractors

Navigating the Canada Revenue Agency’s tax regulations for personal services businesses can be complex. Owners must understand specific rules to ensure compliance and avoid potential penalties.

Amelia recently started a personal services business in Edmonton, Alberta, and is concerned about how to properly classify and manage her income according to CRA guidelines. She wants to ensure she’s compliant but is unsure if her current business structure is optimal for tax purposes. Should Amelia restructure her personal services business to better comply with CRA regulations?

Recommendation: Tax Compliance Review and Restructuring Advice

KWB recommends a thorough review of Amelia’s current business structure and its adherence to CRA personal services business rules. This assessment will help determine if restructuring is necessary to optimize her tax position and ensure ongoing compliance.

Defining a Personal Services Business (PSB) in Canada

Personal services business tax rules apply when:

• There is an individual who renders services on behalf of the corporation (an “incorporated employee”)
• The incorporated employee or any related person directly or indirectly owns 10% or more of the issued shares of any class of the corporation or of any related corporation (a “specified shareholder”)
• The incorporated employee would be considered an officer or employee of the client but for the existence of the corporation
• The incorporated employee does not employ more than 5 full time employees
• The services are not being provided to an associated corporation
• The corporation’s income is from services performed by the provider on the corporation’s behalf

 

When personal services business tax rules apply, there are two primary tax outcomes:

1. A higher corporate tax rate on personal services business income
   • Any income that is determined to be from personal services business would not be eligible for the small business deduction.
   • In addition to a higher federal tax rate, the provincial tax rate on income from personal services businesses is higher than other income
2. A limitation on the corporation’s expense deductions
   • Deductions that a corporation can claim when considering personal services business income are limited to:
     • Salary paid to the incorporated employee
     • Employment benefits for that individual
     • Expenses that would be allowed if the individual were a commissioned salesperson
     • Legal expenses incurred by the corporation to collect amounts owing to it

CRA Tax Rules and Implications for PSBs in Edmonton

To avoid tax consequences of unexpectedly earning personal services business income, consider these suggestions for managing that risk.

1. Pay out corporate earnings as salary
2. Clearly document relationships stating that the parties have not agreed to an employment relationship
3. Document the level of autonomy the corporation has
4. Consider risk when planning remuneration
5. Consider obtaining a ruling from CRA

CRA Tax Rules for Personal Services Businesses

To make sure all personal services business owners are aware of the tax rules that apply to them, the CRA hosted a webinar and sent stakeholder emails to educate corporations and advisors on the subject.

The CRA is also contacting Canadian businesses until December 2022 to gather documentation about payer/payee relationships. Should you be contacted, your participation is voluntary. If you participate, you will be provided with guidance on correcting any errors that might be found.

Strategies to Mitigate PSB Tax Risks and Avoid CRA Pitfalls

We work with our clients to ensure compliance with all CRA requirements you are subject to, and to maximize your tax savings opportunities.

To become a KWB client, book a free consultation here.