Recently the CRA began an “educational outreach project” relating to Personal Services Businesses (“PSB”). In its media releases, the CRA indicated they would be contacting Canadian businesses to request documentation regarding potential PSBs, but that participation would be voluntary. However, the letters that businesses have received from the CRA make no mention of participation being voluntary, and in fact contain references to the CRA’s authority to inspect the business’s records. We have some doubts that this new CRA initiative is purely educational and believe it may signal a renewed focus by the CRA on the audit of potential PSBs. With that being the case, we wanted to devote this Tax Minute to reminding our clients what circumstances might trigger the PSB provisions and the effects if those provisions are triggered.
The first question you may be asking is: what is a PSB? In order for a corporation to be designated as a PSB, three conditions must be met:
- There must be an individual that performs services for a recipient on behalf of a corporation;
- That individual, or someone related to them, must hold 10% or more of any class of the corporation’s shares; and,
- If the individual provided the services directly to the recipient, they would be considered to be an employee of the recipient.
Even if all three of the above requirements are met, the corporation will not be treated as a PSB if it meets one of two exceptions:
- The corporation has more than 5 full-time employees; or,
- The service recipient is a corporation that is associated with the corporate service provider.
If it is determined that a corporation is a PSB, the tax implications can be dire. Firstly, a PSB’s income is taxed at a higher corporate rate: they are not eligible for the general tax rate reduction or small business deduction and they pay an additional 5% surtax. In Alberta this means a total corporate tax rate of 41% and, once the proceeds are paid via dividend to the individual shareholders, an effective tax rate (including corporate and personal tax) of approximately 60% in the case of eligible dividends and 66% in the case of non-eligible dividends, assuming top marginal tax rates apply.
Additionally, expenses the corporation may claim as deductions are severely limited: the corporation may only claim deductions for salary and employment benefits paid to the individual performing the services, legal expenses required to collect amounts owing, and certain expenses that would be claimable by the individual if they were providing the same services personally. These effects combine to strongly disincentivize operating as a PSB and make it prudent to take steps to minimize your exposure in circumstances where the CRA may determine that your corporation is a PSB.
If you have a corporation that is providing services and are concerned that the PSB rules may apply to you, contact the tax team at Mowbrey Gil today.
Written by Kelly B. Sinn, JD from Mowbrey Gil. This document was written for our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America.