How to ensure compliance with personal services business rules
PSB rules are designed to ensure those acting as employees do not receive a tax benefit by using a business (Getty Images/Thomas Barwick)
The Canadian Revenue Agency (CRA) recently launched a new campaign focused on Personal Services Businesses (PSBs). Bruce Ball, FCPA, Vice President, Taxes, CPA Canada, summarizes the top things service providers need to know.
CPA Canada: Can you explain why the CRA initiated their PSB campaign?
Bruce Ball (BB): Corporations generally pay less tax than individuals, at least those with high tax rates. Therefore, it is quite common to use a corporation to conduct a business that includes a business to which you provide services.
The problem that worries the government are situations where a person, generally considered an employee, offers their services to the ’employer’ through a company in order to take advantage of lower corporate tax rates and receive a tax deferral. The PSB rules are designed to deal with this.
If you set up a business and provide services, the PSB rules apply if four conditions are met. In the case of registered service providers, three of the tests are usually passed. The fourth test is the employee built-in test and usually determines whether your company is a PSB or not. That is, if you provided your services directly and without the involvement of a company, would you be considered an employee or a self-employed person for tax purposes?
CPA Canada: What Are the Two Main Tax Consequences of PSBs?
BB: When a company is found to be operating a PSB, there are two issues related to that income.
First, the rules aim to eliminate the tax deferral benefit by denying the small business owner deduction so you don’t get the small business owner rate and an additional 5 percent tax is levied on PSB income. If a future distribution of corporate income is made to the individual, the combined corporate and personal tax will generally be higher than the personal tax that would have been payable if the income had been derived directly without the use of a corporation.
The second issue raised is that business people are allowed a wider range of spending compared to employees. Thus, if the company operates a PSB, the company expenses that are deductible from PSB income are generally limited to those that an individual could have deducted themselves, plus the salary and benefits that the company pays to the “recorded employee.”
CPA Canada: What practical issues should be considered?
BB: Companies often prefer to hire integrated consultants or service providers. If the service provider is a partnership, the company that hires it must determine whether it is providing its services as an entrepreneur or as an employee. If the person is an employee, then the company shall withhold taxes, CPP, EI and so on. For this reason, it is quite common for companies to only engage registered consultants – the question of employed or self-employed is a key factor in determining whether a PSB exists and is the problem of the service provider.
Factors used in deciding between employees and self-employed include the degree of control the payer exercises over the service provider’s obligations, whether the payer uses their own tools to perform the services, whether the service provider performs the work personally or whether they can commission or subcontract the work (see full list).
It’s also a good idea to have a written agreement outlining the intended relationship. However, the underlying facts must support this – otherwise an agreement may not be relevant.
Being subject to PSB rules because that’s the only way you can find work doesn’t mean you have a tax problem, provided you understand the issues. As mentioned, any salary paid to you during the year is a deductible expense for the company and this allows you to be treated for tax purposes as if you had worked directly for the company as an employee: yours Company essentially only act as an intermediary. The key is that you have to pay it as salary during the year. Unlike business income in general, accrued bonus is not deductible when calculating PSB income.
CPA Canada: What are the key takeaways for stakeholders?
BB: It has always been important to ensure that when you use a business to provide services, you assess whether or not it qualifies for the small business relief.
What matters now is that you look at your arrangements and make sure you’re not doing a PSB, or if you do then make sure you’re taking action to address the issues created by the PSB rules.
If the company operates a PSB, the goal for many is to ensure that you pay no more tax than if you were a direct employee. If the issues are not resolved and the PSB rules apply, there can be significant costs (especially given that there may be more than one tax year open for assessment).
CPA Canada: What is the scope of the CRA campaign?
BB: The CRA launched a campaign to help industries that hire frequent incorporated workers to understand and comply with their tax obligations. The CRA states that the goal is to inform both payers and payees of their obligations so that they can make informed decisions about their working relationship. CRA officials began reaching out to taxpayers in June and will continue to do so through December 2022.
According to the CRA, no compliance action will result from the review, but companies will be instructed to ensure errors are corrected and that they comply with the Income Tax Act. Aside from this initiative, it is unknown if the CRA will conduct more extensive investigations into companies for the possible application of the PSB rules in the future.
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For more details on CRA’s campaign, which focuses on personal service businesses, see the latest post on the CPA Canada Tax Blog.