Tax Rules for IT Contractors and Consultants

Are you an IT contractor or a consultant working on a contract basis? If that’s you, you should be aware of how the personal services business rules impact IT contractors and consultants and their taxes. The PSB rules have changed, so it’s important that you go through this article.

What is a personal services business and why should you care? A PSB can be described as follows: If it weren’t for the corporation, you’d be a regular employee. In other words, you are an incorporated employee. Bear in mind that the personal services business rules for IT contractors and consultants can have really bad consequences (for you).

Impact of Personal Services Business Rules:

Number one, the small business deduction is disallowed. Number two, a special penalty tax is levied, thereby increasing your taxes. Number three, deductions for expenses that you incur are denied. As a result of all these factors, your corporation’s tax rate increases from a low of 15.5% to a high of 39.5%.

Now that you know what the consequences of a PSB are let’s look at the six factors that the CRA uses in assessing if your corporation is a PSB.

Factor No. 1 – Control:

Your employer exercises control over how and when you perform your work, and you have to, regularly or daily, report to your supervisor directly. If these factors are present, then it’s more likely that your corporation will be considered a personal services business.

Factor No. 2 – Tools & Equipment:

If your employer provides you with all the tools & equipment that you need to do your job, then it’s more likely that you will be considered to be a PSB or personal services business. Tools & equipment includes such things as your computer, your fax machine, software, etc. Note that if your employer reimburses you for your tools & equipment you purchased it’s the same as the employer having purchased those tools & equipment directly for you.

Factor No. 3 – Subcontracting Work:

If your employer does not allow you to hire subcontractors to help finish a project, then you are more likely to be considered a personal services business.

Factor No. 4 – Financial Risk:

If you do not take any financial risk whatsoever, it’s more likely that your corporation will be considered a personal services business. Let’s look at some examples of financial risks. Number one, your employer pays for all of your costs like car expenses, your home-office expenses, cell phones, internet, supplies, and other out of pocket costs. Number two, you are not liable to the end-customer if the project is a failure because of you. Number three, you don’t have any risks for bad debts, so you know that the payment from your employer, is, in fact, guaranteed.

Factor No. 5 – Opportunity for Profit

If you do not have the opportunity for profit, it’s more likely that your corporation will be considered a personal services business. Let’s look at some examples. Number one, you are paid an hourly wage instead of on a per-project basis. Number two, you are not entitled to a percentage of the employer’s sales or profits. Number three, you are not paid on a milestone basis or upon successful completion of the project.

Factor No. 6 – Financial Dependence:

If you are financially dependent on your employer you are more likely to be considered a personal services business. Often times, this means that your only customer is your current employer, as opposed to having multiple numbers of customers.

So far, all this sounds like doom and gloom but there’s good news. The good news is now you know what the CRA looks for when assessing whether a business is a PSB. Go back to your contract to see if there are things that you can change or consult an accountant to see how you can avoid the PSB rules.

Additionally, if you have an IT company, you may be eligible for the very favorable SR&ED tax credit.  Please read our article on tax credits for technology companies in Waterloo to find out more.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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