Personal Services Business – Be aware incorporated employees!

Where an individual renders services through a corporation of which he/she (or a related person) is a specified shareholder (i.e. owns 10% or more of issued shares directly or indirectly) and for the presence of the corporation, the individual might be reasonably regarded as an officer or employee of the entity for which the services are provided.  In this case, the corporation is considered to be carrying on a “personal service business” unless there are more than five full-time employees throughout the year.  The CRA now takes the position that the requirement can be met where the corporation employs throughout the year five full-time employees and at least one part-time employee.

Income from a personal service business is taxable at full corporate rates and will not receive the small business tax credit.  Income from a personal service business is not eligible for the general corporate rate reduction, meaning that such income will be taxed at significantly higher levels than regular corporate income.  Currently, personal services income is subject to federal tax at a rate of 33%, plus the Provincial rate of 11.5% (For Ontario), totaling to 44.5% V.S. the general corporate tax rate of 26.5% and the small business rate of 12.2%.

Furthermore, deductions for a personal services business are restricted to:  The salary, wages, or other remuneration of the individual providing the services; the cost of other benefits or allowances provided to him/her; certain amounts expended in connection with the selling of property or the negotiating of contracts; and legal expenses paid in the year on account of collecting amounts owed for services rendered.  All other expenses which would otherwise be deductible to the corporation are specifically denied.

Although the specific rules are intended to capture the incorporated employees (i.e. athletes employed by sports teams), this provision may also pick up management companies serving professionals (i.e. doctors, dentists), especially if the professional’s spouse is an employee.

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email us for further advice.