The Tax Implications of Running a Personal Services Business
A Personal Services Business is a business that is being run by someone who is basically working as an incorporated employee. They would normally be considered an employee of the business that hires them, but they have incorporated and are choosing to provide services through their corporation.
Normally, in Canada, corporations are taxed at a lower tax rate compared with the marginal rates an individual is charged. This allows for a deferral on taxes because the corporation pays less and is able to accumulate money faster. As well, businesses are known for being able to deduct a broad spectrum of expenses. However, one lesser common variant of corporate taxation in Canada, Personal Service Businesses, are not provided the same treatment. These entities, merely because of the nature of the duties undertaken, have a reduced ability to deduct expenses and a significantly higher tax rate than the normal corporate tax rate.
What is a Personal Services Business?
A Personal Service Business is a business that is providing services through a corporation, but the work being done is basically the same as a regular employee. These business entities exist when someone is acting on behalf of a corporation and provides services to another corporation. As well, the services undertaken would normally be performed by an officer or employee of that other entity. That individual providing the services is called an incorporated employee. Once an incorporated employee is established there are two requirements for a personal service business to exist, the following list provides these requirements:
- That the incorporated employee who performs the service or any person related to the incorporated employee is a specified shareholder of the corporation providing the service.
- If not for the existence of the corporation, that incorporated employee would reasonable be considered an officer or employee of the entity receiving the services.
How are Personal Services Businesses Taxed?
Once it is determined that a corporation is running a Personal Service Business, then it will pay higher income tax rates, as well as be limited in its ability to deduct expenses. With regards to higher income tax, compared to the general corporate tax rate in Ontario of 26.5% and the small business rate of 13.5%, a personal service business has a tax rate of 44.5%.
With regards to a limited ability to deduct expenses, most of the common expenses that a business would normally be able to deduct will become prohibited once classified as a personal service business. Ultimately this boils down to the fact that a Personal Service Business may only claim deductions that a normal employee could also claim. For example, a Personal Service Business cannot deduct legal and accounting expenses, supplies and materials, travel and car expenses, and office space costs which a normal business would be able to deduct.
If you are being classified as a Personal Service Business, or you are worried that you might be one, please do not hesitate contact Rosen Kirsten Tax Law. We are here to help!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.