The Final Nail in the Coffin for Personal Service Business? What You Can Do to Fight Back
Tax advantages and deferrals amongst corporations is nothing new, so it is no surprise that Bill C-48 which received royal assent on June 26, 2013 would have looming implications for many businesses including personal service businesses (PSB). This article will look to provide an overview of PSB’s, how the new rules affect them, and what you as a small business can do to avoid being classified as PSB.
What is a PSB?
A personal service business as defined by the Canada Revenue Agency is when an individual provides a service on behalf of the corporation to another corporation when logistically they could just be an employee for that corporation if not for the existence of their own corporation. In other words, the individual is an ‘incorporated employee’ in substance.
For many small businesses choosing to incorporate as a Canadian Control Private Corporation (CCPC) allowed corporations to be eligible for the small business deduction (SBD). The SBD allows the first $500,000 of operating profit to be taxed at 15.5% even if it was classified as a PSB. Compare this to a non-incorporated individual who earned in excess of $130,000 would be taxed at 46.4%. So it is quite easy to see why some individuals who are technically not actual corporations would abuse this loophole and gain tax deferrals and benefits. For more information on the SBD please check out the Canada Revenue Agency website here.
Bill C-48 was designed to stop the abuse and amend PSB rules. Not all small incorporated businesses are classified as PSB’s but for those that are; the amended income tax laws have severe repercussions. If the CRA classifies a small business as a PSB, the following changes apply:
• The business will no longer be eligible for the Small Business Deduction leading to an increase in their corporate tax rate. In Ontario, this increases from 15.5% to 25.5%. The tax rate is also further exacerbated to 38.5% as a result of the loss in the 13% general rate reduction.
• Major restrictions in terms of deducting business expenses. The PSB will no longer be able to write off standard business expenses and deductibles are generally limited to remuneration and benefits for the incorporated employee.
• There is potential for further tax penalties as a result of reassessment. As part of their process, the CRA may generally audit up to the previous three years with a tax rate of 50% or more.
This chart illustrates the difference between a standard small business that is eligible for the SBD versus one that is classified as a PSB
|Standard Small Business||Personal Service Business|
|Corporate Tax Rate||15.5%||38.5%|
|Corporate Taxes Paid||$77,500||$192,500|
|Income after corporate tax||$422,500||$307,500|
What can you do to avoid being classified as a PSB?
As a small business owner, there are some options that you can take. However, since the CRA evaluates each incorporated business on a case to case basis, there is no guarantee that these options will work for everyone.
• The first option is to make sure your corporation has at least five full-time employees, the more the better!
• The second option is ensure that you provide your services to multiple clients/customers thereby diversifying your sources of income.
Individuals who work as information technology contractors and consultants are particularly more vulnerable to the new PSB rules. Please check out this video that discusses how PSB rules affect IT contractors and consultants from our website for more details about what you can do.
Remember that PSB classification is only year to year, you may be labeled a PSB one year and then a legitimate incorporated business the next and vice versa. So make sure you adopt our suggestions as well as speak to a tax professional.
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.