Canada Revenue Agency’s (CRA) enforcement of Personal Service Business
In the late 1960’s, Ralph Sazio, who led the Hamilton Tiger-Cats to three Grey Cups, decided it would be better for him, tax-wise, to contract his services to the club rather than be an employee so he incorporated. CRA took exception to this and denied the expenses he was claiming. He proceeded to challenge this decision in court and won his case.
This prompted CRA to change the rules preventing individuals from incorporating themselves to realize the tax benefits of a small business corporation. Thus, a Personal Services Business is denied the Federal Small Business deduction on the first $500,000 of active income resulting in increased tax rates for that corporation. On top of that, PSB’s are also denied most of the normal expenses attributable to running any other corporate organization. The only allowable costs that can be deducted are wages and employee benefits with a few minor exceptions. Effective for tax years beginning after October 31, 2011, the general rate reduction has also been disallowed for all PSB’s, again increasing the corporate tax rate.
There has been a concerted effort by CRA to “track down” some of the corporations that could, realistically, be classified as a PSB, going back, in my experience, to 2008 tax years resulting in disallowed expenses, increased tax rates and huge tax reassessments. Most PSB’s are corporations with one or two shareholders performing a service for a few (often only one) customers. These small corporations file their tax returns, pay their GST and payroll remittances etc. in the belief that they are complying in all respects with what is required.
CRA has hit the Information Technology (IT) industry the hardest with their PSB designations which is interesting considering the Government of Canada actually hired most of them through employment agencies to provide IT services directly to various Government departments. It was the hiring agencies that “required” these individuals to incorporate in order to provide these services in the first place. They were not allowed to perform services for other clients while working on Government technology. Once the upgrades were all completed, CRA audited many of them and deemed them to be PSB’s. Ironic, if not downright nasty.
Criteria used by CRA to determine whether a company is a PSB may include:
1. Number of employees (has to have more than 5 full-time before it is NOT a PSB)
2. How many clients or customers the company has
3. How much control the contractor has over the work being done by the company
4. Who owns the tools for the work done
5. Whether there is a chance for profit or risk of loss
6. The degree of integration between contractor and company
In order to be considered an independent contractor, there must be no commitment regarding number of hours worked, little or no supervision, invoices issued by contractor, no benefits received from the contracting company, and use its own office and equipment to do the work. Without the use of the intermediary corporate structure, the individual performing the service would reasonably be considered an employee of the company or person paying the corporation for the service.
Which brings us to another issue that is resulting in all of these PSB’s being created. In Alberta, in particular, many of the large oil and gas operating companies and related service companies have, for years, required the people performing duties for them become incorporated. This would include contract operators, tradespeople, safety consultants, etc. The individuals would normally be employed by these large companies, have regular payrolls with Canada Pension and Employment Insurance premiums deducted and paid by the company as well as applicable withholding tax. By “requiring” the individuals to incorporate, the large company does not perform any of the payroll functions and that becomes the responsibility of the incorporated individual. Also, these contractors are further “required” to possibly provide their own vehicle, fuel, cell phone, insurance, tools and pay accounting costs to file their annual tax returns. If deemed a PSB, these operating expenses will be disallowed by CRA. Only the shareholder’s wages and benefits become deductible for tax purposes. The individual either complies with the request of the contracting company and registers with CRA or looks elsewhere for work.
There are rules pertaining to employed versus self-employed, CRA Guide RC4110(E), that would be used in determining whether an employer-employee relationship exists. By requiring an employer-corporation relationship, the employer is navigating around its responsibility towards an individual and CRA seems to be allowing that while penalizing the individual “required” to meet the employer’s criteria.
According to the Provincial Government’s 2012 report, Alberta has led Canada over the last decade with an increase of 15,288 (11.9%) in the number of new establishments with less than 50 employees. My guess is that many of these may be considered PSB’s if CRA ever chooses them for an audit.
Sometimes the economy is such that people really have little choice in the structure under which they earn their living. Incorporate or find a job elsewhere seems to be the prevailing attitude with many of these hiring organizations. They earn their income by contracting their contractors services.
If you would like further information or a more detailed history, please do not hesitate to contact me.
Coleen Gordon CGA