Has your small corporation been declared a personal services corporation? A personal services corporation, also known as personal services business comes with several limitations. You need to understand what could happen to you if your incorporated business is declared a personal services corporation.
Tax issues that could arise if declared a personal services business
Your incorporated business can face serious tax issues when it is declared a personal services business by the CRA. You need to understand that this type of business is not considered as active business income. This means that the CRA will not allow you to claim any small business deductions. If you can’t claim small business deductions, the income you receive will be taxed at a significantly higher personal rate. If you take money out of the personal services business in form of dividends, you could end up paying a tax of up to 58% when the personal and corporate tax rate are combined. This is a hefty tax bill that you need to avoid at all costs.
Personal services businesses cannot claim so many standard deductions
As a PSB, you may find yourself unable to claim some of the standard business deductions that other incorporated businesses are claiming. For instance, if you are a shareholder of the personal services business, you are considered an incorporated employee. Because you are not considered a self-employed individual, you cannot claim any money you spend on accounting, supplies, legal fees, and other similar costs. You can only deduct the salary and benefits made to the employee.
It’s very important to ensure that you understand how the CRA will classify your business. If your business is classified as a personal services corporation and yet you have been claiming small business deductions and business expenses, you could face possible tax penalties for this. The CRA can perform an audit and examine the business records from previous years. This means that you could be found to owe the CRA money for years of getting it wrong.
How to ensure your small business is not classified as a PSB
First, you have to ensure that your business employees at least 5 full-time employees throughout the year. Also, the corporation should only provide services to an associated corporation. Some businesses will only work for a single client on a long-term basis. This is one of the ways the CRA may classify your business as a PSB. Your corporation should have more clients and at least a few people to help out as employees. Make sure the people who assist you to conduct your services are considered employees and not independent contractors.
For CRA to determine whether an individual is an employee or an independent contractor, they evaluate the following factors:
- How much control do you have over the person’s work
- Who provided the tools and equipment needed to get the work done
- What risk of profit or loss is the person exposed to
- What’s the degree of integration to your business
Also, ensure you are not viewed as an employee of a particular client because the CRA could also assume the same thing and perform an audit to confirm.
Sohail Afzal, CPA, CMA, MBA
Sohail Afzal, (CPA, CMA, MBA) is the founder & CEO of GTA Accounting Professional Corporation. He is a highly experienced Chartered Professional Accountant and businessman himself and understands the challenges that many businesses face when it comes to cash flow management. As an experienced business consultant & tax advisor, he is helping companies grow by providing the technical, financial, and contractual information necessary for strategic decision-making.