Independent Contractor vs. Personal Services Business in Canada 

Many entrepreneurs in Canada opt to work as independent contractors through a corporation rather than as employees. This choice offers them greater autonomy and numerous tax advantages. Moreover, businesses often prefer hiring contractors to employees because it allows them to sidestep obligations like paying CPP, EI, vacation, and remitting payroll deductions to the Canada Revenue Agency (CRA). This practice is prevalent in sectors like IT, construction, transportation, and trucking. 

However, it’s crucial to understand that the Income Tax Act mandates that income be taxed based on economic realities, not just legal structures. If the CRA classifies you as a Personal Services Business (PSB), your corporation might miss out on many tax benefits typically available to Canadian corporations. 

What is a Personal Services Business (PSB)? 

A PSB is a corporation that offers services to another entity, services that an employee of that entity would typically provide. An individual, termed an “incorporated employee,” renders these services for the corporation. If the corporation didn’t exist, this individual would likely be viewed as an employee of the service-receiving entity. 

The CRA designates a corporation as a PSB if it: 

• Has an individual performing services on its behalf. 
• This individual is a significant shareholder (holding 10% or more shares) or is related to a significant shareholder. 
• Without the corporation, this individual would be seen as an employee of the hiring entity. 
• Employs fewer than six full-time employees throughout the year. 
• Doesn’t provide services to an associated corporation. 

However, the CRA and courts use four tests to ascertain if a relationship is more akin to an employer-employee or contractor: 

• The control the employer has over the contractor’s duties. 
• How integrated the contractor’s work is with the employer’s business. 
• Whether the employer supplies the tools for the job. 
• The contractor’s potential for profit and risk of loss. 

Both parties’ intentions, the service provider and the hiring entity, are also considered. 

Implications of Being Classified as a PSB 

• Tax Rates: PSBs can’t avail of the small business deduction or the general rate reduction. Instead of the reduced tax rates of 12.2% (for qualified small corporations) or 26.5% (for other corporations) in Ontario, PSBs face a hefty tax rate of 44.5%. 

• Expense Deductions: PSBs can only deduct specific expenses, such as the incorporated employee’s salary or wages, certain corporate expenses related to selling property or contract negotiations, and legal fees for collecting service-related dues. This restriction means PSBs can’t claim many standard business operating expenses. 
• Potential CRA Penalties: Incorrectly classifying your corporation can lead to penalties and interest if the CRA later determines it fits the PSB criteria. 

Mitigating PSB Tax Implications 

If you’re in a situation where you’re only hired through a corporation and the PSB rules apply, it’s advisable to distribute the corporation’s income to yourself (the incorporated employee) as a salary. This approach ensures the income is taxed at standard personal rates, bypassing the elevated PSB corporate tax rate. 

However, if you choose this route, you must: 

• Register a Payroll Program account with the CRA. 
• Deduct income tax and CPP from each wage payment. 
• Timely remit the employer’s CPP contributions, deducted income tax, and the employee’s CPP share to the CRA. 
• File a T4 slip and T4 Summary annually. 
• Maintain proper records. 

It’s worth noting that as the corporation’s controller, your salary won’t be subject to EI premiums, and you won’t be eligible for EI benefits if the contract ends. 

Dividends: It’s generally not advisable to distribute dividends from a PSB because they’re taxed at the corporate level at 44.5%. You’d also have to pay personal tax on these dividends. 

CRA’s Voluntary Disclosure Program (VDP): If you suspect your corporation might be a PSB and you’ve made errors in past filings, consider the VDP. This program offers relief to those who voluntarily correct their tax filings before the CRA takes notice. While you’ll still owe taxes and possibly interest, you might receive relief from prosecution, penalties, and some interest.