Incorporated business & tax rates
Aug 25, 2012 / 5:00 am
As a Chartered Accountant serving small business owners in the Okanagan I am often asked by unincorporated business owners about the tax benefits of incorporation. While there are many tax advantages to incorporating a business, there are also tax risks to be considered. Among those risks are the risks that an incorporated business be deemed by CRA to be a Personal Service Business and become subject to a high rate of tax.
What is a Personal Services Business (“PSB”)?
Generally speaking an incorporated business runs the risk of being deemed a PSB where the corporation is providing services to a single client, where the individual performing the services (or someone related to the person) owns 10% or more of any class of shares of the corporation, and without the use of the corporation, the individual would reasonably be regarded as an employee.
This risk of being deemed a PSB often arises in consulting or other service business where large employers offer contracts to existing employees on the condition that the former employee’s carry out the contract through a corporation.
What are the Tax Consequences of a PSB?
In the event that CRA deems your corporation to be PSB, your corporation will not be able to claim the small business deduction. In B.C. this will increase the corporation’s tax rate from 13.5% to 38%. In most cases this higher rate of tax means that the business would have paid less tax on the income earned had it not been incorporated but rather received directly as an employee or unincorporated subcontractor. In addition, being deemed a PSB may significantly limited your ability to deduct expenses in the corporation. All things considered, a PSB determination significantly reduces, if not eliminates, any benefits of operating a business through a corporation.
Does your business run the risk of being determined a PSB?
To answer this question one must understand what it means to say “without the use of the corporation, the individual would reasonably be regarded as an employee of the person or partnership paying a fee to the corporation?” In general, if the answer to any of the following questions is ‘yes’ the corporation may be considered a PSB.
- Does the corporation have very few customer/clients? Or just one?
- Is the work conducted at the customer/clients office?
- Does the customer/client provide the tools necessary to complete the job?
- Does the customer/client determine how and when the work will be done?
- Are you restricted in the ability to hire someone else to complete the work?
- Does the customer/client pay on a regular basis without you submitting an invoice?
The determination of whether a corporation will be considered a PSB will be based on case by case basis and even if the answer to more than one of the questions above is ‘yes’ the business may not be a PSB.
If you think your business is at risk of being deemed a PSB, you should discuss the issue with your accountant and lawyer prior to incorporating your business. Existing corporations that run the risk of being deemed a PSB should consult their accountant for planning strategies that can be implemented to mitigate the tax cost associated with this determination. Taking steps now to mitigate the risk can save time, money, and headaches in the future.
Read more Focus on Business articles
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