Are you an incorporated subcontractor? Have you thought about your risk of double taxation?
Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.
As a practicing CPA, the question I often hear is ‘I work up North and my employer is requiring me to incorporate.
Is this a good idea?’
In truth, if you want to work with this employer you probably don’t have a choice about incorporating.
But, there is a big risk called a personal services business you are going to want to know about, before taking the leap.
I hope that this article will help you and incorporated subcontractors you know to manage their tax risk.
What is a personal service business?
A personal services business or PSB can pop up when an individual would normally be an employee if it were not for the existence of the corporation.
A PSB takes the tax risk away from the employer and put it onto the employee that is required to be incorporated. Let’s go through an example.
Tom is looking for a job.
An Alberta-based oil company offers him a 12-month contract position with full-time hours and generous benefits.
However, the contract comes with the requirement that Tom performs his services through a corporation.
Tom is eager to take the lucrative job, so he decides to incorporate.
Tom is the only shareholder of his corporation and the only employee.
Tom’s only client will be his employer, the oil company.
Tom’s corporation invoices the oil company for the services Tom personally performs.
Tom receives payment for these services bi-weekly.
Overall Tom’s contact with the oil company is very similar to an employment contract because.
Tom receives benefits, is employed full time, has a long-term 12-month contract, and is paid bi-weekly.
In this example, Tom meets the conditions of a personal services business because:
Tom’s structure is a very common set-up for employees working up North in construction, but it can also affect individuals working in the medical field and many other professions.
Let’s dive into some of the reasons you should care about a PSB label.
"A PSB takes the tax risk away from the employer and put it onto the employee that is required to be incorporated." – Jillian Battaglio, CPA, CA
What are the risks of a PSB?
If your incorporation is labelled as a personal service business your taxes get considerably worse for three reasons:
PSB Risk # 1
A personal services business is not eligible for the general tax rate reduction or the small business deduction and the government even adds on an extra 5% for good measure.
All of this means you’ll be paying an extra 32% of income tax on your corporate earnings if you are labelled as a PSB by CRA.
PSB Risk # 2
A PSB is extremely limited in the expenses it can deduct. Deductible expenses are limited to:
Salaries, wages, and benefits paid to employees who are directly working for the employer
Expenses directly associated with selling property or negotiating contracts
Legal expenses incurred in collecting amounts owing
And that’s it.
Insurance, bank fees, accounting fees, and supplies cannot be claimed.
Some creativity could pop up around vehicle or room and board allowances along with other employee benefits but the audit risk goes up significantly with a PSB label.
PSB Risk # 3
Rather than three months to pay any balance owing on your corporate tax return available to most small businesses – the Canada Revenue Agency only allows PSBs two months.
So, yes, Personal Services Business do suck.
How can you mitigate the risks of a PSB?
The risks associated with a PSB are pretty nasty; but, there are a few things you can do.
Option # 1: Act Like A Regular Business
Having multiple clients, advertising your services, providing your own tools and equipment, setting your own hours, and hiring your own subcontractors or employees can all be beneficial.
Option # 2: Pay Out All Your Profits As Wages
One of the deductions available to PSD is wages.
To reduce your tax risk and avoid the extra 32%, pay any profits out to yourself as wages or employee benefits and issue yourself a T4.
Dividends won’t do the trick and will still incur the extra 32%. Paying wages to spouses or children is also a bad idea.
As an example, Tom pays his wife $80,000 a year for administration services.
This will get denied by the CRA and can cause double taxation for Tom because his wife isn’t the employee under contract with the oil company.
The CRA will deny the wages being deducted from Tom’s corporation.
...And the CRA will still charge his wife tax on the $80,000.
"Yes, personal services businesses do suck." – Jillian Battaglio, CPA, CA
Option # 3: Consider Voluntary Disclosure
If you think you’ve been in this position for a few years and are beginning to sweat, there is a band-aid available.
You can opt to voluntarily disclose your PSB status to the CRA.
You will have to pay any additional income tax, but a voluntary disclosure can reduce interest or penalty if your voluntary disclosure application is approved by the CRA.
Are You A PSB?
That’s all I have for today on personal services businesses.
I hope that this article has helped you or an incorporated subcontractor you know, manage their tax risk.
If this topic has interested you, be sure to check out our other blog articles and consider subscribing to one of our membership plans so you can be a well-informed business owner.
Article Written for TaxWrx by Chartered Professional Accountant Jillian Battaglio.