The penalties for breaking tax laws may be serious, as well as the Canadian Revenue Agency is increasing its examination of personal services business (PSB).
It has become essential to determine if the newly established business is operating as a Personal Service Business and how that might affect the entity’s tax status as more individuals and proprietorships in Canada opt to incorporate.
The personal services business (PSB) service is delivered via a company and the person performing the job is regarded as an employee if they do it directly.
The CRA engaged in a number of actions in this area, including hosting a webinar in February 2022 and sending stakeholder letters to inform businesses and advisors about the regulations and how to follow them.
The Canadian Revenue Agency stated in a stakeholder email delivered in July 2022 that they will be contacting Canadian companies between June and December 2022 to request paperwork on their payer/payee connections.
Although companies who participate in the initiative, instructed to make sure they fix any errors and comply with the Income Tax Act, taxpayer involvement in the program will be optional.
The applicable personal services business regulations take into account some best practices for taxpayers who provide services through corporations.
Personal Services Business – PSB
Many taxpayers retain non-employees to offer services rather than hiring them directly, whether to meet a short-term need, acquire specialized knowledge, or otherwise fill a job that is not appropriate for full-time employment.
If an individual or company is delivering the services will determine whether there is a considerable income tax risk. If the service provider is an individual, the main income tax question is whether the person is an employee or an independent contractor.
Additionally, the taxpayer may well be responsible for penalties for failing to make required withholdings for income tax, the Canada Pension Plan, and employment insurance. Thus, the payer and payee share tax risk.
However, in cases when the payer hires a business to provide services, the service provider bears the majority of the income tax risks related to accurate tax computation and payment.
The income of tax regulations demand:
- Earnings from a running firm that qualifies for the small business deduction, or
- Revenue from a PSB
The payee may have a sizable tax obligation if they perceive their service income as qualifying for small business tax rates but the CRA classifies it as coming from a personal services business. However, the revenue calculation has no influence whatsoever on the payer, which is one of the reasons many taxpayers choose to do business with service providers that are corporations.
Tax Hit For Corporations Earning PSB Income
There are two primary tax effects when the personal services business regulations are in effect: a higher rate of corporate taxes on the PSB revenue and a cap on the corporation’s cost deductions.
1- A higher rate of corporate taxes on the PSB
The personal services business is not qualified for the small business deduction in corporate revenue. That income would be subject to an extra 5% tax.
Cost increases even further when the provincial tax takes into account. For instance, in Ontario, the tax rate for PSB income in 2022 is 44.5 percent, compared to 12.2 percent for income that qualifies for the small company rate.
If a top-rate taxpayer in Ontario received the after-tax PSB income as an eligible dividend, the total corporate and personal tax would be 66.3 percent. In Ontario, the top rate on ordinary income is 53.53%, which may result in an integration cost of income taxes of approximately 13%.
2- Limited Deductions
If the PSB guidelines are in effect, the firm may only eliminate the following for computing PSB income:
- The “incorporated employee’s” wage
- Benefits of employment for the person.
- The kind of costs that covers the person that has a commission-based salesman.
- Legal costs that the company pays to recover money that owes to it.
When do the Personal Service Business rules apply?
When these four criteria satisfy the personal services business regulations often apply:
- The person offering the services, or someone connected to them, is a designated shareholder of the company.
- If the person renders services directly (i.e., without employing a business), they regarded as a taxpayer’s employee (i.e., an incorporated employee)
- Throughout the tax year, the business doesn’t have any more than five full-time employees.
- The corporation receives payment from the supplier for services rendered on the corporation’s behalf.
Who is Considered to be an Incorporated
The other three criteria are the major question for someone delivering services through a business is whether they recognize as an employee if they weren’t working for the organization.
Control: The extent to which the payer influences the obligations of the service provider.
Tools & Equipment: Yet if the payer provides the services using their own equipment.
Ability to Subcontract: The service provider must perform the task itself, or they may pay someone else to do it or subcontract it.
Financial Risk: The supplier of the service is suppose to invest in their company and has to pay for expenditures before processing payments for services.
Opportunity for Profit: The vendor of the service faces a possibility of revenue as well as a probability of loss.
Multiple Clients: Delivering comparable services to more clients demonstrates self-employment as well.
Managing Personal Service Business Risks
As you can see, because of the significant tax rate gap and the limitations on expense deductions, receiving PSB revenue suddenly in a business can have serious tax consequences. Here are some tips for controlling your risk from PSBs.
1- Payout Corporate Earnings as a Salary:
Paying the service provider a wage is one type of risk management that uses to reduce prospective PSB income.
As a result, the amount of business revenue is subject to Canadian personal service.
Remember that only wages received will count as a deduction.
Therefore, managing the related tax risk requires being able to identify when a PSB could exist.
2- Clearly Document the Relationship:
The objective is to explicitly describe the connection in a written agreement that specifies the parties have not committed to an employment relationship for those who are confident they are not operating a PSB.
Even with the agreement in place, it is still necessary to take into account the risk of a CRA review or audit.
3- Personal Service Business Risk When Planning Remuneration:
It’s important to keep in mind that providing a salary can lessen the impact of an unexpected PSB review while deciding on compensation levels and whether a salary or dividend should be provided.
Salary paid throughout the year is deductible, unlike a dividend given from income received after taxes. The dividend’s classification as small business income after taxes may also be problematic.
4- Consider Obtaining a Rule from CRA:
The CRA webinar stated that it is also feasible to get a ruling from CRA to establish whether a personal service business provider is an employee or an independent contractor.
Even though this option provides more assurance, there is still a chance that the CRA will determine that there is an employment relationship where self-employment might be successfully justified.
Therefore, a ruling request could only call the CRA’s attention to the arrangement if it is obvious that the service provider is not an incorporated employee.