Many independent contractors who provide services in IT, engineering, consulting and other areas operate their business through own corporations. Small Business Corporations are eligible to claim Small Business Deduction and pay in Ontario 15.5% income tax rate on first $500,000 of net income. Also, corporation would write off all business related expenses (i.e automotive, office, advertisement, office rent, telecommunication, salaries to family members and etc.). Very often corporate income would be cut in half or more after deducting all expenses. Then the company would pay corporate 15.5% corporate tax on net income and distribute remaining retained earnings in dividends (often splitting dividends between family member shareholders through special structure share capital), often trig erring no or very low personal tax. You may know that in Ontario income tax is zero on first $38,000 of dividends.
Does it sound good? Maybe it is too good to be true! Obviously, CRA is not happy with this situation. There are special rules for Personal Service Business (“PSB”) otherwise called “incorporated employees”. As of October 31, 2011 the rules became even tougher.
What are tax consequences to be a Personal Service Business?
PSB is not allowed to have Small Business Deduction and even General tax reduction. In Ontario corporate tax of PSB would be 39.5% (compare with 15.5% of Small Business Corporation!). PSB is very limited to expenses it is allowed to deduct. Generally, only salaries paid to shareholder would be allowed.
If your corporation is reassessed as a PSB that would create a huge tax bill!
What are some characteristics of a business that would cause PSB designation?
1. One or very few clients.
2. Working mainly at client’s office
3. Using client’s equipment and tools.
4. Being listed in client’s telephone directory.
5. Having business card issued in the name of client’s corporation.
6. Degree of integration with client.
7. Contractor might be reasonably considered as an employee of the client.
CRA Guide “Employee or Self-employed” rc4110-11e provides more details.
What to do to minimize risk?
1. Review terms of your contract if you have one or prepare and sign a contract if you don’t have one.
2. Try to get as many clients as possible
3. Use your own tools
4. Establish in the contract right to work from your office.
5. Get your business cards. website, HST number, business name (don’t use numbered company).
6. Involve in Research & Development and claim R&D credits. Doing that might show that your company developing products.
7. Discuss your situation with accountant in advance. Don’t wait till CRA reassess your tax return
For professional help please contact us
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4580 Dufferin Street Suite 401 Toronto, ON M3H 5Y2
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67 Alpaca Drive, Richmond Hill, ON L4E 0G1