If you own and operate as an incorporated small business, you may be surprised to learn that the CRA may classify you as a Personal Service Business (PSB). Below we explore how a PSB is defined, its potential disadvantages to your corporation and simple tax planning tips. If at any time you are unsure which corporate tax rate applies to your business’ operations, reach out by phone or email for personalized advice from McNabb Lucuk LLP.

Determining a PSB Classification

The PSB rules are set out in the Income Tax Act. Generally, you may be considered a Personal Services Business if you are an individual performing work on behalf of a corporation to which you are a shareholder or related to a shareholder. Due to the corporate structure of a business, the individual is not an employee, the business does not employ more than 5 full-time employees throughout the year and services are not provided to an associated corporation.

A common example we see in the Peace region is a company hires tradespeople as incorporated contractors rather than as employees. This allows the hiring company to avoid paying CPP, EI and other employee benefits and payroll costs while paying the corporations in exchange for hours of work.

For example, Bob is a welder who incorporates Bob’s Welding and is the primary shareholder. Bob’s Welding only works for one client, TradeBuild. TradeBuild sets the hours that Bob works and compensates him on an hourly rate. Bob’s Welding is at risk of being considered a PSB by the CRA.

Reducing Costs of a PSB Classification

When income is reported by the Personal Service Business, it is taxed at one of the highest rates. The federal rate on PSB income is 33% plus a provincial rate of 8% (AB). This means an average tax rate of 41% or $41,000 on $100,000 of income.

Issuing dividends as remuneration is not deductible against income under a PSB. Meaning the corporation would not only be required to pay tax on the full amount of income earned, but the recipient would also pay personal income tax on the dividend received.

The easiest way to reduce taxes owed by a PSB, is to pay out earnings in the corporation as wages to the incorporated employee. The employee then pays income tax at their marginal personal tax rate. That same $100,000 in income from above, when paid out as wages to Bob, would be subject to an average personal income tax rate of only 24%, or just under $24,000. The corporation still incurs other payroll expenses, such as CPP, but the overall costs would be significantly lower compared to paying the PSB tax rate on the income.

Although deductions are very limited for a PSB, wages, benefits and allowances provided to employees are permissible. Other deductions include legal expenses to collect amounts owing to the corporation and costs of selling property or negotiating a contract on behalf of the corporation.

Penalties for Inaccurate Reporting

If the CRA determines your incorporated business meets the criteria to file as a PSB and it hasn’t, you could be subject to penalties and interest for filing incorrectly and paying the wrong tax rate.

If you think you may fall into the Personal Service classification, reach out to your accountant or email [email protected] or [email protected] here at McNabb Lucuk LLP. We can provide you with personalized advice to avoid costly penalties and unnecessarily high taxes that can be avoided by smart business accounting and early tax planning.

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If you own and operate a small incorporated business but only work for a single business, you may be at risk of being classified as a Personal Service Business (PSB) by the CRA. This not only reduces the deductions your business is entitled to, but can also mean significantly higher tax rates for income held by the corporation. In our latest blog, we explore how the PSB classification is determined and provide solutions for reducing its tax burden.