Profit and Policy: Are you a PSB?

All references to a spouse include common-law partners. All references to the ‘Act’ or the 'ITA' mean the Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended. All references to the ‘Regulations’ or the 'ITR' mean the Income Tax Regulations. The following should not be construed as legal nor tax advice. Consultation with your usual tax/legal professional is advised. Please contact us to discuss the contents of the article herein.

Good morning Toronto. From our past articles, you will have gained the impression that corporations tend to receive much more favourable tax treatment compared to individuals. In the past, this has led many individuals to incorporate and provide services that are no different from an employee working for an employer in an attempt to capture corporate tax benefits (such as lower tax rates) from work that is functionally employment.

To address this, the Act includes a specific category of corporations: Personal Services Businesses (PSBs). If a corporation is determined to be a PSB, there are significant income tax implications.

Federally, the base corporate tax rate (Part I) is 38%. After a 10% federal abatement that all corporations qualify for, the federal tax rate is actually 28%. For almost all corporations, the federal government permits a general tax reduction of 13%, making the effective federal corporate tax rate 15%. As discussed in Profit and Policy: Unpacking the Small Business Deduction, income that qualifies for the SBD is taxed at 9% federally. In Ontario, this system is simplified: 3.2% on income that qualifies for the SBD, and 11.5% on all other income.

A PSB is defined in subsection 125(7) of the Act to exist where:

• There is an individual (‘incorporated employee’) who performs services on behalf of the corporation; AND
• The individual is a specified shareholder (owns more than 10% of all voting shares by any means); AND
• If the corporation did not exist, the individual would be reasonably regarded as an employee of the payor (corporation’s clients); AND
• The amounts paid to the corporation for services rendered were from an arms-length corporation (not related); AND
• The corporation employed fewer than 5 full-time employees throughout the year.

Historically, the CRA and Tax Court have looked at several factors to determine if an employee/employer relationship exists. This determination is case-specific - there are no set factors which immediately 'condemn' a corporation as a PSB. I can distill these questions to:

• Who has the right to determine how, when, and where work is performed?
• Who provides the tools, equipment, and resources required to carry out the work?
• Does the incorporated employee bear any real chance of making profit or suffering loss?
• How integrated is the incorporated employee in the payor's business structure?

As a PSB, many of the usual tax benefits afforded to corporations are denied. PSBs cannot claim the Small Business Deduction. PSBs do not receive the 13% general tax reduction, and are subject to an additional 5% federal surtax. For a PSB with a Permanent Establishment in Ontario, its tax rate would be 44.5% (28% federal + 5% surtax + 11.5% Ontario), which is still lower than the 53.53% top marginal tax rate (for Ontarians making over ~$253k) from 2024. The PSB taxation rate is roughly equivalent to the marginal tax bracket of an Ontarian making between ~$150k-$178k (44.97%), so if the corporation’s expected income was above this threshold, it may be advantageous to be a PSB. However, if the corporation pays all of this money as a salary/dividend to the incorporated employee, this may erode the perceived tax benefit.

A PSB is also severely limited in its ability to deduct expenses. In an effort to mirror the deductions that would be permitted to employees under the tax system for individuals, PSBs are not allowed to deduct advertising, rents, travel, CCA for equipment, and other deductions that corporations are generally entitled to. As per paragraph 18(1)(p) of the Act, PSBs are limited to deducting wages paid, benefits provided (such as the employer portion of CPP/EI), and some legal expenses (related to recovering payment for unpaid work performed).

As with any corporation paying an employee, PSBs are subject to the usual payroll obligations: to register for a payroll account, withhold and remit Income Taxes/CPP/EI, and issue T4 slips.

To conclude, these punitive measures (as well as the usual significant compliance, regulatory, and paperwork burden associated with having a corporation) are efforts to discourage employees from forming their own corporations. However, as discussed, there may exist some situations (corporation’s gross income is >$250k) where there may be potential tax benefits to a PSB, provided that all of the corporation’s income is NOT flowed down to the employee.

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