Incorporated Employees and Tax Implications Linked to Personal Services Business (PSB) 

If you’ve recently been approached with a contract proposition that suggests you incorporate yourself, tread carefully. This trend is particularly popular in sectors like IT and transportation. While incorporating in Canada is a straightforward process, many overlook the concept of a Personal Services Business (PSB). Some tax professionals might even incorrectly file taxes for these corporations, allowing them to claim the small business deduction and other non-eligible expenses. This results in the employer not having to handle source deductions, while the incorporated employee benefits from reduced tax rates. However, this can lead to complications. 

Understanding Personal Services Business (PSB) 

A PSB is essentially a corporation set up to offer services that resemble employment. While there’s nothing inherently wrong with this, it’s crucial for shareholders and incorporators to understand the associated tax implications. 

Tax Implications of PSBs: 

• Full Rate Taxable Income: PSBs can’t claim the small business deduction against their income. They also can’t avail the 13.0% rate reduction at the federal level. The general corporate tax rate in Canada is 33.0%, but after a federal abatement of 10.0%, it’s effectively 28.0%. PSB income is taxed at this 28.0% rate before any additional taxes. 

• Additional Federal Tax: There’s an extra 5% corporate tax on PSB income at the federal level, raising the overall federal corporate income tax rate to 33.0%. 

• Limited Deductions: PSBs have restricted deductions. They can only deduct salaries, wages, benefits, allowances paid to the incorporated employee, and certain other specific expenses. 

Determining PSB Status: 

The Income Tax Act (ITA) defines a PSB. If a corporation has an “incorporated employee”, it’s considered a PSB. This status is determined based on various factors, including the relationship between the incorporated employee and the client, and whether it’s more akin to an employment or contractor relationship. 

Exceptions: 

Certain corporations aren’t considered PSBs, such as those with more than five full-time employees throughout the year or if the income is from an associated corporation. 

Tax Tips for PSBs: 

• Pay Salary to Incorporated Employee: One way to mitigate high corporate tax rates is by paying a salary to the incorporated employee. This can reduce or even nullify corporate taxes. 
• Seek an Advance Income Tax Ruling: Given the expansive and intricate definition of PSB in the ITA, it’s wise to seek an advance income tax ruling from the CRA. 

Common Examples of Incorporated Employees: 

• Driver Inc.: The transportation industry, especially long-haul trucking, often encourages drivers to incorporate. This can be to sidestep payroll contributions, overtime, and other payments. 

• IT Contractors: The IT sector frequently hires contractors as corporations rather than as employees. If you’re considering a contract in IT, it’s essential to determine whether you’d be classified as an employee or a contractor.