When it comes to deciding what category your company stands in, the last thing you would want (for the sake of tax deductions and benefits) is to be placed under the category of a ‘personal services corporation’.
First of All, What is a Personal Services Business?
A personal services corporation is basically when a corporation conducts services using an incorporated employee and not a contractor. The problem with this is obviously that those employees cannot get access to the tax deductions and benefits that contractors receive.
This probably leaves you wondering as to who is classified as an ‘incorporated employee’ and what makes a business go under this category in the first place. There are a few determining factors that the CRA looks at to determine whether someone is an employee or a contractor.
First and foremost the CRA looks at the contract that was made and what both parties actually agreed their intention was when they decided to work together. Whether the person is being hired as an employee or contractor should be very clear in the initial contract that was signed. However, just the contract isn’t enough to determine what is really going on.
Even after viewing the contract the CRA goes a step further and evaluates many other variables. First of all, how much control does the one who is giving the money have over the worker’s schedule and activities?
If the payer is completely in charge of making the schedule and demands a certain amount of hours every day then it is more of an employee relationship then a contractor one. Furthermore, if the payer is providing all the working supplies then it is once again more of an employee-employer relationship and not really one based on business.
Another factor that is important is whether there is any financial risk involved for the worker. The less financial risk involved, the more it appears to be an employee and not a contractor position.
The CRA will actually ask questions about all of these factors to both of the parties involved in this relationship and will likewise decide what is really going on behind the scenes. All of these factors are important, but there are two major conditions which really tip the scales and help the CRA decide which decision to make.
If the company did not exist, you would be considered an employee of the person or entity to whom you are providing services.
If you or any other person in your company who is providing the services is a direct or indirect shareholder of the corporation and holds at least 10% of issued shares.
If these above two variables turn out to be true then it can become very easy to be categorized as a personal services corporation and not a business. However, these rules can be canceled out if the corporation has 5 or more employees staffed throughout the year. If there are regular employees working then they will not be categorized as a personal services business.
So to go over it with an example: A computer software engineer has been registered as a corporation and is offering services for a year now under this title. Their tax evaluation comes back very negative and they are surprised to see they owe thousands of dollars in taxes because the CRA decided they are no longer a corporation, but rather a personal services corporation.
How did the CRA come up with this conclusion? They saw that he held 40% of shares for his company and he was working regular employee hours and working under conditions that normal employees work under. He also didn’t have any other employees staffed for the past year.
Once again, if you get categorized under a personal services corporation you can not cash in on the benefits and tax deductions that are available for businesses and contractors. You also can’t get tax deferrals or claim business expenses either.
If you want to continue to keep your workers and continue working the way you are but still get the tax deductions available for contractors and businesses then you should book an appointment with a chartered accountant who can help you make all the right decisions and save as much as possible. This is a great example of why individuals should always consider tax planning before opening a business, incorporating, or making any other big decision with their company.