Are you self-employed or a contractor with only one client? You may need to verify the CRA criteria for self-employed versus Personal Services Business.

Operating as an independent contractor is not uncommon. Hiring independent contractors or becoming a freelancer has been gaining popularity over the past few years. But while there are many advantages to operating as an incorporated business or sole proprietor, if you only work with one client, you may be considered a Personal Services Business (PSB). And that comes with many tax implications.

Read on to determine if your business falls under this definition and the tax consequences.

What is a Personal Service Business?

Personal Services Business (PSB) is the CRA definition for a business arrangement in which an individual offers their services to clients as an independent contractor or corporation while maintaining a relationship structure that resembles that of an employee-employer dynamic rather than a business-to-business one.

You are considered a Personal Service Business if you meet the following criteria:

  • You are a specified shareholder, holding a minimum of 10% of shares of your corporation, and you, or someone related to you, is the employee performing services for another business
  • Were it not for the corporation you created, the above incorporated employees would be considered an employee of the business receiving the services
  • Your corporation does not employ more than 5 full-time employees throughout the tax year, and
  • Your corporation’s income is from services performed by the incorporated employee on behalf of the corporation that is not from an associated corporation

Personal Service Business Vs. Independent Contractor / Self-employed

So, how is a Personal Service Business different than an independent contractor or self-employed position?

Independent contractors and self-employed professionals have control over their work, including when, where, and how they complete tasks. They often have multiple clients and are responsible for managing their own business operations, such as invoicing, taxes, and insurance.

An independent contractor may fall under the Personal Services Business classification if the provision of services requires them to behave the same way as an employee (i.e. they have no control over when, where and how they complete the services they have been contracted for). Even if you are registered as a sole proprietor or operating as an incorporated business, if you provide services in the same way an employee does, you are at risk of falling under a Personal Services Business or an “incorporated employee” for tax purposes.

You are under the client company’s control when the client dictates what you do and how it is done. Thus, the CRA will label you as a Personal Services Business. Using a different label doesn’t eliminate the fact that you are an employee according to the government’s point of view.

What Are the Tax Implications of Being a Personal Services Business?

Once the CRA determines that you are a Personal Services Business, your business is ineligible for standard business expenses — including Small Business Tax Deductions. You also put your business at the risk of audits for previous tax years — which might cause significant consequences for your business due to increased tax liability.

In addition, by fitting the Personal Services Business classification, you lose the ability to claim the reduced tax rate that small businesses enjoy on the first $500,000 income. Businesses claiming the small business deduction benefit from a federal income tax rate of 9%. In addition, small businesses also benefit from lower rates on provincial income taxes. In Ontario, that means a reduced rate of 3.2%.

A Personal Service Business is ineligible for the general tax and small business deductions. This means they are subject to the full federal and provincial/territorial tax rates, plus an additional 5% on Personal Services Business income. As of 2023, this represents a tax rate of 33%.

The CRA PSB Pilot

In 2022, the CRA launched the Personal Services Business Pilot. The program intended to identify companies that hire PSBs, as well as companies that might be operating as PSBs. The goal of the pilot is to provide outreach and education to help such businesses identify their tax obligations.

The initial phase of the program ended in December 2022 and identified that a large portion of potential PSBs had been claiming the small business tax deduction and would need to amend their tax returns.

Phase 2 of the pilot started in October 2023 and will be completed by June 2024. At this phase, the CRA will examine approximately 2100 corporations and review 2022 tax filings.

If you are a PSB, you might receive communication from the CRA inviting you for a voluntary interview and notifying you that your files are under review.

How to Avoid the PSB label?

As demonstrated, the tax implications of a Personal Service Business designation are significant and can have serious repercussions for your business. To avoid being classified as a PSB, here are some actions you can take:

  1. Make your own schedule: take charge of your schedule and work hours to ensure the CRA considers you a self-employed individual or contractor.
  2. Diversify your clients and projects: having multiple clients and ownership of your work tools will also help distinguish your business from a Personal Services Business.
  3. Update your contracts: to safeguard you and your clients, your contracts need to state that you work as an independent entity.

Still not sure if your business would fall under the Personal Services Business designation? Contact us today to take the necessary steps to protect your business. Our team of experienced accountants helps you differentiate between self-employment and a PSB classification. We can also help you navigate each scenario to ensure the best tax outcomes.  Contact us for more information.

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