A friend was recently offered a contract position with an oil and gas company, but there was a catch: he needed to form a corporation and get a GST number before he could start working. If you work in oil and gas, you know that this is not an uncommon request.
Incorporated contractors and consultants in all industries need to be careful in a situation like this. The CRA can define incorporated employees as a Personal Services Business (PSB), which has major tax consequences. But fear not -- we’ve got your back! We wrote this to help you understand what a PSB is and how to avoid it.
Who might qualify as a Personal Services Business (“PSB”)?
The CRA may designate you a PSB if you are incorporated, but only have one client and your work arrangement looks very similar to that of an employee. Or, if you’re an incorporated contractor and you’ve worked for the same company for more than a year.
Essentially: If the CRA believes that you are operating as an employee of a company under the guise of an incorporated contractor or small business, they can designate you a Personal Services Business.
Why this matters
Working with incorporated contractors is common in any industry that is project-focused: IT, management consulting, engineering, project management, etc.
It’s a practical way for companies to hire talent for a limited time, without having to bring them on payroll and provide them with all the other unnecessary tasks and costs that come along with onboarding a new employee.
Here are the two main incentives for businesses to hire contractors over employees:
Employment Standards & Expenses:
Overtime, EI, CPP, vacation, stats, sick days, health benefits, life and disability insurance, liability insurance, training, issuing computers and phones, company events, and paying for un-billable time.
There was a case a few years ago where an oil and gas producer had a rig explode, resulting in a casualty. The operating company had no actual employees on site, they were all independent contractors, doing their job. The operator was able to protect themselves from the liability of the explosion.
Of course some people took advantage of the system, so the government had to bring in these PSB rules to curb the abuse.
What is the consequence of being deemed a PSB?
If you are designated as a Personal Service Business, the CRA's view is that you should have been an employee from the start of the working relationship. Your corporate income is no longer Active Business Income. They ignore the corporation and treat you as if you have been an employee the entire time.
Which is what makes this rule so unfair. In the majority of cases, the contractor was required to be incorporated by the company hiring them. But instead of going after the company hiring you, the CRA goes after the contractor who is likely just trying to make a living for their family.
Here are the consequences if you get deemed a PSB:
You lose your Small Business Deduction: your tax rate will increase from the small business rate of 11% to 33% in Alberta.
Disallowed deductions: you can no longer use business expenses like cell phone, accounting fees, supplies, office space, etc. as write-offs.
- Penalties and Interest: the government will get their full tax rake on your income, but it also will penalize you significantly for attempting to avoid taxes.
How to mitigate the risk
If you are at risk of being deemed a Personal Services Business, there isn’t one thing you can do that will guarantee your safety. But each of these helps a bit, and the more you have, the safer you are:
Set your own schedule:
Autonomy over your own schedule is probably the most important factor.
Get a few different clients:
If you work full time for only one client, it’s important to try to take on at least one or two side gigs. Invoice them and get paid. Make it official.
If you do get deemed a PSB, things get messy and the penalties and interest add up quick. Paying yourself with wages, rather than dividends, and making regular remittances minimize these costs and inconveniences.
Take financial risk:
The more equipment you bring to work, the better. When you can, use your own vehicle, computer, phone, and office. Pay your own way for courses, conventions, and professional dues. Pay rent for a desk.
Have a clear contract:
Sign a contract with a definite end. Clearly identify your corporation as an independent contractor. Explain the risks you take. Charge fees for use of assets owned by either party.
Don't get too nervous if you think you might be at risk for designation as a PSB, we can assess your risk and help you mitigate. Call or email if you want to chat about it further.
Read more about Corporate Tax topics that may be helpful to you and your small business.
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