Nowadays, it has become a common practice in some industries to hire contractors, consultants and freelancers to fill out temporary positions.
These situations carry significant income tax risk, and that risk depends on whether an individual or corporation is providing the services.
I have a friend who come to me that they have been offered a position of IT consultant, but they have been required to incorporate before they could start.
Of course, there are a lot of benefits of incorporation that come with the lower tax rate and limited legal liability but at the same time, it comes with risks.
What is the risk involved?
CRA may disagree with the arrangement and classify your corporation as Personal Service Business.
So, what is a “Personal service business”?
In general, a personal services business exists where the individual would be considered to be an employee of the payer if it were not for the existence of the corporation. In other words, the service provider would have acted as an employee while providing services instead of acting through his corporation. This individual is sometimes referred to as an incorporated employee.
Some of the industries where this practice is common to include:
- Trucking
- IT Consultants
- Accountants
- Construction
- Catering
If PSB rules apply you will:
- Lose all the benefits of incorporation
- PSBs are not eligible for the small business deduction, or the general tax rate reduction you will be paying taxes at a higher rate which is about 44.5% in Ontario
- You cannot deduct any other expenses other than salary and wages paid to the incorporated employee
If you think that your corporation is at higher risk of being classified as PSB then it is better, you continue as a sole proprietor and don’t get into the trap of PSB.
In case your business is picked up by CRA for evaluating PSB conditions and it is determined that you fall in the category of PSB, you will receive a notice from CRA for filing incorrect tax details which can attract penalties and interest for the wrong tax rate.
The key to reading your risk of classifying as PSB is to demonstrate that you are not in an employer-employee relationship with the company hiring you.
In order to mitigate the risk before incorporation and before signing any contract it is always better to approach a good accountant to understand the implication of rules to your situation.
We at Rav Bhatia PC provide a vast array of services and can help you out in resolving all such confusion relating to personal service businesses.
Book a free consultation call with us today!