How To Avoid Being Labeled a Personal Services Business By CRA
If you’re an independent contractor in the oil patch or IT industry and are concerned about your status with the Canada Revenue Agency, here’s what you need to know.
It was not uncommon that agency staff advised professionals and consultants to incorporate before signing contracts. Many professionals and consultants incorporate a business because they’re worried about not being hired if they don’t adopt a corporate structure, but they also look forward to the tax benefits of incorporation, and they trust the staffing agency. However, the CRA is watching. The type of business may not be the same as its status as they thought. PSB rules may apply; CRA may consider an incorporated individual working as a contractor to be an employee of the company they are working for. This classification is punitive and comes with a great tax cost unless the bellowing exceptions are met:
the corporation employs more than five full-time employees (except contractor) over the course of the year
the services are provided to an associated corporation
The advantages of incorporation:
Oil and gas companies may require independent contractors to incorporate because incorporation allows them more flexibility in dealing with layoffs and severance payments. On the other hand, the tax benefits for contractors include:
The first $500,000 of income is taxed at 11% in Alberta
A broader range of deductible expenses, such as a vehicle, insurance, home office, amortization etc.
May be able to defer income taxes,
Could take advantage of the $800,000+ lifetime capital gains exemption when those shares are sold
Both employers and independent contractors benefit from the arrangement, so it is logical that the arrangement would have been intended. However, when companies use third-party contractors to offload their payroll compliance burden, some of that risk transfers to the contractor. The PSB rules were enacted to prevent employees from incorporating and taking advantage of corporate tax benefits.
The tax consequence being labelled as a PSB is:
Effective for 2016 and later taxation years, the corporate tax rate for personal services business is 33%. If combined with its provincial tax rate, for example, Alberta, it is 41% for PSB.
Allowable tax deductions are limited to:
Allowances and payroll-related expenses incurred in the year for incorporated employees only, such as salary, wages, and other remuneration and benefits.
The legal fees for negotiating the contract and collecting the balance owing for services rendered
Fees for selling property
The PSB designation is yearly only. For example, you can be labelled a PSB for one tax year, a CCPC or another private corporation for the other tax years.
How to determine a PSB classification?
Due to both parties wanting this arrangement, the original intention of contractor agreements and invoices was thought to be artificial by CRA. They depend on case-specific facts and rely on the following four criteria but are not limited to the four to assess whether the PSB rule will apply.
The degree of control
Control is an employer’s degree to control a contractor’s activities. Specifically, it is a right to control other than actual control, for example:
- the contractor can subcontract work
- A regular meeting was set up between the employer and the contractor
- the employer controls many aspects of how and when the work is performed
Degree of integration
- Does the contractor have multiple clients? If the contractor had only one client, the employer’s most likely scenario would be integrated.
- Do the services render were integral to the client’s business?
- Will the contractor be wearing the employer’s uniform? Will they be using the employer’s office?
Ownership of Tools
- The company provides all the tools and equipment and is responsible for repairs
- Although the contractor provided the tool and equipment, but he or she was reimbursed by the company.
Chance of profit and risk of loss
- If there’s a mistake on the job, will the contractor have to fix the mistake for free?
- Does the independent contractor pay operation expense.
How to Reduce the Chance of a PSB Classification?
To enhance your argument as an independent contractor, you need to put the following in place:
– Provide service to multiple clients in a year
– Using your tools. Do not accept allowance for tools.
– Invoicing clients based on the services you provided
– Pay a rental fee when using our clients’ workspace and office equipment
– Include “the possibility to sub contract your work” on the hiring contract
– If you find a mistake in your job, correct it without charge and at your own cost
If the PSB status is unavoidable, the easiest way is to pay out total contract earnings as wages to an incorporated employee. The tax rate for PSB can be avoided, for example, 41% in Alberta. This way, corporate tax is paid at zero; PSB remitted the employer’s portion of payroll tax to CRA, and the incorporated employee pays income tax at their marginal personal tax rate.
If you are worried about your business being deemed a personal service business, please contact a professional.