Everything independent consultants and personal service businesses (PSBs) need to know.
The Canada Revenue Agency (CRA) continues to closely monitor the activities of independent consultants and companies providing services through incorporated structures. While the rules for determining whether a company is a Personal Services Business (PSB) have not changed, the CRA has recently intensified punitive measures for non-compliance. This article aims to inform independent consultants and PSB owners about the new audits and changes that could impact their business.
What is a Personal Services Business (PSB)?
A PSB is generally a company created to provide services that would otherwise have been provided under an employer-employee relationship. In other words, if the company did not exist, the person would be considered an employee rather than an independent contractor.
The CRA assesses the nature of the contractual relationship to determine if a company should be classified as a PSB, using the following criteria:
- Employer/Employee Relationship: If, without the company, the worker would be considered an employee of the entity receiving the services.
- Designated Shareholder: The incorporated worker (or a related person) is a designated shareholder of the company.
- Company Size: The company does not employ more than five full-time employees throughout the fiscal year.
- Source of Revenue: The amounts received by the company for services provided do not come from an associated company.
Tax Implications and Enhanced Penalties
If the CRA determines that a company is a PSB, the tax consequences can be significant. Unlike other businesses, a PSB does not benefit from the general tax rate reduction or the small business deduction, meaning it is subject to the full federal and provincial tax rates on all taxable income, plus a 5% additional charge.
Furthermore, deductible expenses for a PSB are limited:
- Salaries and Wages: Salaries and wages paid to the company’s employees who provide the services are deductible.
- Benefits and Allowances: Benefits or allowances paid to the employees concerned.
- Expenses Related to Sales or Contracts: Certain expenses related to the sale of goods or contract negotiations.
- Legal Fees: Legal fees incurred to collect amounts owed to the company.
How to Avoid Being Classified as a PSB ?
To avoid the consequences of being classified as a PSB, consultants and businesses should structure their operations to demonstrate that they are genuine independent businesses. Here is a checklist based on recommendations from the Association of Professional Canadian Consultants (APCC):
- Business Registration: Ensure that your business is registered and has a commercial license if needed.
- Business Name: Choose a unique name for your business rather than a government-assigned number.
- Office and Personnel: Maintain a dedicated office, even if at home, and use a separate telephone line and bank account for the business.
- Brand Image: Use professional business cards, letterhead, and email signatures. An online presence through a website or social media is also crucial.
- Clear Contracts: Draft detailed contracts specifying the terms of the relationship, including payment and termination clauses.
- Client Diversification: Avoid relying on a single client for all your revenue, which strengthens your position as an independent contractor.
- Control of Work: Ensure you control the manner and methods of work to achieve the desired results for your clients, thus limiting the chance of being considered an employee.
- Subscribe to Liability Insurance: Protect yourself against lawsuits. Some clients may require proof of coverage before hiring you.
- Subscribe to Disability Insurance: Guarantees income in case of illness or injury and helps maintain a favorable tax status with Revenu Québec and the CRA.
- Asset Protection Strategies: Use proactive approaches to protect your finances from the CRA and lawsuits, such as keeping major assets (residence, RRSP) in the name of the lower-risk spouse, as well as more complex strategies.
- Membership in Professional Associations: Joining organizations like PAIC can strengthen your status as an independent consultant and provide support in case of disputes with the CRA.
Operating as a PSB can have significant tax implications, especially with the increased scrutiny from the CRA. It is crucial for independent consultants and affected businesses to understand these obligations and structure their operations correctly to avoid being classified as a PSB. By following PAIC guidelines and consulting with tax or legal professionals, you can protect your business from undesirable tax consequences.
For more information and personalized advice, feel free to schedule an appointment with one of our advisors here:
