How to Avoid Being Treated as a Personal Services Business

How to Avoid Being Treated as a Personal Services Business

 In Business Owners, Small Business, Sole Proprietor, Tax

My friend was recently offered a contract position as an IT consultant, but was required to incorporate before he could start. This has become common practice for many companies hiring consultants and freelancers. Today, I am going to share what I told my friend when he came to me for advice. I will also explain how you can avoid the biggest tax trap consultants face when incorporating – being treated as a Personal Services Business.

What Are the Benefits of Incorporating a Consulting Business?

Firstly, it is important to know that there are many benefits of incorporating as a consultant or freelancer:

  • Limited legal liability – Incorporating can protect your personal assets from creditors of your business. A sole proprietorship offers no such protection.
  • Flexible remuneration options – As an incorporated contractor, you can choose to take money from your company as a dividend or salary. This can affect many areas of your life such as tax, mortgage capacity and RRSP contribution room.
  • Income splitting – Corporations provide more opportunities to income split with family members compared to sole proprietorships.

But, with benefits come risks. Let me explain…

What is a Personal Services Business or PSB?

When you are hired as a consultant, freelancer or independent contractor, there is the risk that CRA will disagree with this categorization. Instead, CRA may consider your corporation and the business hiring it to be in an employee-employer relationship.

Or, in tax terms, CRA will consider your corporation to be a Personal Services Business or PSB.

As a PSB, your business will lose most of the benefits of incorporating discussed above. In fact, a corporation that is a PSB:

  • Pays tax at a high rate of about 45% (Ontario and British Columbia).
  • Can only deduct wages as a business expense, and not much else.

So here is the truth…

The PSB rules are very punitive! If your corporation is at high risk of being classified as a PSB, then you are likely better off to continue as a sole proprietor.

 

Luckily, there are steps you can take to protect yourself from falling into the PSB trap and reap the benefits of incorporation.

How Can I Avoid Personal Services Business Classification?

The key to reducing your risk of being classified as a PSB is to demonstrate that you are not in an employee-employer relationship with the company hiring you.

This can include:

  • Working with multiple customers rather than being financial dependent on one.
  • Establishing an independent presence for your corporation (e.g. website, business cards).
  • Setting your own work schedule and working independently without supervision.
  • Providing your own tools and equipment to complete the work.
  • Maintaining the right to subcontract the work or hire an assistant in your contract.
  • Demonstrating that you have a chance for profit but are equally at risk for losses as a result of your contract.

These are just some of the many measures you can implement to protect yourself. Before signing a contract or incorporating, it is important to speak to a knowledgeable professional to understand how the PSB rules apply to your particular situation.

Not sure if incorporating is the right choice for you? Contact us for a consultation.

 

The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.

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