Personal Services Business Rules

Understanding Personal Services Business (PSB) Rules and Criteria under CRA

Operating a business in Canada comes with various tax rules, especially for those providing personal services. One critical classification by the Canada Revenue Agency (CRA) is the Personal Services Business (PSB). This classification can have significant tax implications and consequences for a corporation if it meets specific criteria. In this article, we will explore the rules and criteria for a PSB, the tax implications of being classified as such, the consequences of non-compliance, and strategies to ensure that your business does not fall into the PSB category unintentionally.

What is a Personal Services Business (PSB)?

A Personal Services Business is a corporation that provides services through its incorporated employee (referred to as an "incorporated employee") to another business. According to the CRA, a business is classified as a PSB if the following criteria are met:

1. Incorporated Employee Criteria: The individual providing the services to the client would be considered an employee of the client if it were not for the existence of the corporation.

2. Ownership and Control: The incorporated employee or anyone related to them owns 10% or more of the corporation's issued shares (by value or number).

3. Exclusion of Employment Agency Corporations: If the corporation provides services as an employment agency, it is excluded from being classified as a PSB.

4. Employees: The corporation employs less than 5 people.

Tax Implications of a PSB Classification

Being classified as a PSB can lead to significant tax consequences:

1. Loss of Small Business Deduction: A PSB does not qualify for the small business deduction, which allows qualifying businesses to pay a lower tax rate on the first $500,000 of active business income.

2. High Corporate Tax Rate: Income from a PSB is taxed at a much higher rate, around 33% in most provinces, as opposed to the lower active business income tax rate.

3. Limited Expense Deductions: A PSB is limited in the types of expenses it can deduct. Only specific expenses that an employee could claim, such as salaries and benefits, can be deducted. This significantly reduces the tax planning opportunities available to other corporations.

4. Double Taxation: After paying corporate tax at the higher PSB rate, shareholders may face additional tax when dividends are distributed, leading to double taxation on the same income.

Consequences of Violations and Non-Compliance

Failing to comply with PSB regulations can result in:

1. Reassessment by CRA: If the CRA determines that your corporation should be classified as a PSB, it may reassess previous tax returns, leading to a higher tax bill and interest on the unpaid taxes.

2. Penalties: Deliberate misclassification or failure to meet the CRA’s PSB criteria may result in penalties, further increasing the tax burden.

3. Increased Scrutiny: Being classified as a PSB can invite further scrutiny from the CRA, leading to potential audits and additional compliance burdens.

Strategies to Avoid Being Classified as a PSB

To avoid falling into the PSB category, businesses should consider the following strategies:

1. Contractual Relationships: Ensure that the contractual relationship between the corporation and the client clearly establishes that the corporation is providing services as an independent contractor. The contract should reflect that the corporation controls how the work is done and has the opportunity for profit and risk of loss.

2. Multiple Clients: Providing services to multiple clients can help demonstrate that the corporation is operating as an independent business rather than an employee-employer relationship.

3. Subcontracting: If feasible, subcontracting work to other independent contractors can further support the case that the corporation is running a business rather than acting as an employee.

4. Proper Documentation: Maintain proper documentation, such as contracts, invoices, and financial records, to substantiate the corporation's independent status.

5. Operational Control: Ensure that the incorporated employee has significant control over how, when, and where the work is performed, and is not subject to the client's direct supervision.

6. Review and Audit Preparedness: Regularly review the corporation’s status and operations to ensure compliance with CRA regulations. Being prepared for potential audits by maintaining detailed and accurate records can also be helpful.

Conclusion

Understanding the rules and criteria for a Personal Services Business under CRA Canada is crucial for any corporation providing personal services. The tax implications and consequences of being classified as a PSB can be severe, including higher taxes, limited deductions, and potential penalties. By implementing the strategies discussed, businesses can ensure they operate within the CRA's guidelines and avoid the costly repercussions of PSB classification.