Are you a Personal Services Business (PSB)? We often hear about individuals who decide to incorporate while working as an employee for a business. But is it really beneficial to do so?
Let’s look at an example. Joe works as an employee and earns employment income (a T4 slip) in Alberta. On July 1, he incorporates. Although he has incorporated, he continues to work for the same employer in the same role. Instead of being paid personally, income is now earned through his corporation. Joe’s corporation does not have any employees, nor does it perform work for any other customers. Joe’s company would be considered a PSB.
tax rate increases significantly
PSB’s can be identified by the following characteristics:
- An incorporated employee
- Provide services
- Has less than five full time employees
- Own 10% or more shares in the incorporated company
- Works for only one customer, where they are regarded as an employee or officer
Joe’s corporation provides the same services that he would perform for his employer, as if he was working as an employee. Therefore his corporation is considered a personal services business.
If the CRA considers you to be a personal services business, your corporate tax rate would increase significantly. This is because the corporation would no longer qualify for the small business deduction. PSB income is subject to the federal corporate tax rate of 28% plus the general provincial corporate tax rate of 12% for a total tax rate of 40% for Alberta companies. That’s 13% above the general rate of 27% and 28% more than the small business tax rate of 12%. This change was effective for taxation years beginning after October 31, 2011.
lose the ability to deduct some expenses
You would also lose the ability to deduct the same expenses that a small business does. Joe’s corporation is now only able to claim the cost of salaries and benefits to him personally, and a few other allowable expenses.
What this means is that there will be a significant tax cost when earning the income in the corporation and paying it out as a dividend compared to earning the same income personally or taken as a salary. Further, there will only be a small tax deferral associated with retaining the income in the corporation for a period of time.
Example of the impact:
Let’s assume that Joe’s corporation earns $ 200,000 per year.
|Small Business||Personal Services Business|
|Federal tax rate||10%||28%|
|Provincial tax rate (AB)||2%||12%|
Without the small business deduction or general rate reduction, you can see that the amount of taxes payable significantly increases, leaving less income to grow and invest in your business.
If you think that you might be a PSB and have been claiming the small business deduction, please give us a call to discuss planning opportunities. Finding out that the CRA has surprisingly reassessed you as a PSB would be a very costly event. CRA has the ability to go back and reassess tax returns from previous years as well. This could result in significant penalties and interest, in addition to the taxes owing as a result of the change in tax rate.
Consequently, if you are considered a PSB it would be best to conduct your business as an unincorporated contractor under these new rules. That is not to say that corporations are totally out of luck. If set up as an incorporated company, businesses can still bonus out income to the owner employee so that the income will not be subject to the 40% corporate tax rate, and thereby avoid a significant tax cost.
Another key consideration is that if you are deemed to be a PSB the expenses that you are allowed to deduct in calculating your taxable income are more restrictive than if you are not a PSB.
KWB is here to answer your questions about the Personal Services Business (PSB) rules and how they affect your decision to structure your business.
If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.
Thanks to Stephanie Kwan of KWB for providing much of this content.