Personal Service Businesses

“Be sure before concluding that the PSB rules do not apply.”

With corporate tax rates declining and small business deduction limits increasing, practitioners are probably receiving more enquiries regarding how clients can provide personal services through a corporation.

Clients should be reminded that, even though tax rates may make a corporation seem desirable, the CRA has not changed its view on what constitutes a personal service business (“PSB”).

The exclusions from the PSB rules for corporations that employ more than five full-time employees, or which receive payment from associated corporations, are the only two legislated exemptions from the PSB rules.

If a corporation is viewed to be a PSB, no small business deduction is available in respect of that personal service business income. Furthermore, the corporation is only entitled to deduct expenses that an employee would be entitled to deduct, as well as salaries paid to the “incorporated employee.”

The recent case of 1166787 Ontario Limited (“PSB Co.”) versus R. (2008 TCC 93) confirms that nothing has changed in this area and adds the awarding of costs to the equation.

In this case, PSB Co. was required to prove that its employee (“Ms. Lee”) should not “reasonably” be regarded as an officer or employee of a person or partnership to whom or to which the services were provided, but for the existence of PSB Co.

The main test in this area is determining whether a “reasonable” person would view the individual providing the services to be an employee or an independent contractor with respect to the work provided to the payor.

While the case dealt with the determination of personal service business status, the same analysis applies to the determination of employee versus independent contractor.

In this case, Justice Miller confirmed that “The only issue to be decided in relation to the definition is whether Ms. Lee would reasonably be regarded as an officer oremployee of [the payor] but for the existence of the Appellant.” The facts were not contested and the conclusion reached by the court, that PSB Co. was a PSB, is not surprising. The court’s awarding of costs to the Crown, however, provides an interesting twist.

While your clients may not want to heed your advice regarding PSB or independent contractor status, the possible awarding of costs to the Crown increases a client’s exposure. Add these costs to the double tax created when the small business deduction is denied (even with GRIP), additional tax from disallowed expenses and interest on underpaid taxes and an aggressive client is entering into an expensive proposition.

It is important to make sure that you and your clients are well informed before concluding that the PSB rules do not apply, or that your client is an independent contractor.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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Cadesky Tax