What is a personal services corporation?
Bluntly, a designation by the Canada Revenue Agency (CRA) that you don't want, because a personal services corporation (a.k.a. personal services business) is not allowed to claim any of the standard business expenses, including the Small Business Deduction.
Technically, a personal services corporation is:
"a business that a corporation carries on to provide services to another entity (such as a person or a partnership) that an officer or employee of that entity would usually perform" (T4012 – T2 Corporation Income Tax Guide, Chapter 4, Canada Revenue Agency).
The CRA Guide goes on to explain that the person providing those services on behalf of the corporation is called an incorporated employee.
Right away, your mental alarm bells should be dinging like mad, because as you know, this is the basic tax divide, employee versus business person. Business people (whether sole proprietorships or corporations) have many more potential tax deductions available to them than employees.
The Canada Revenue Agency generally considers four issues to determine whether a person is an employee or an independent contractor:
- Ownership of tools
- Chance of profit/risk of loss
Are You a Contractor or an Employee? provides detailed explanations of each of these points.
But these may be moot in terms of determining whether or not a corporation is deemed to be a personal services business.
It appears that all that is required for a small corporation to be considered a personal services corporation is:
1) that the person performing the services (you) or any person related to you, is a specified shareholder of the corporation (a person who owns at least 10% of the issued shares of any class of capital stock in the corporation or a related corporation, directly or indirectly, at any time of the year);
2) that you would "reasonably be considered an officer or employee of the entity receiving the services" if not for the existence of the corporation.
You can see, just from reading this last pair of sentences, how difficult it could be for a person with a corporation that has a single shareholder who is doing business with one company to prove otherwise.
From the government's point of view, just calling an employee something else doesn't mean they’re not actually an employee – especially when they're doing exactly what an employee would do.
Corporations who are suddenly deemed to be personal services corporations not only lose their favorable tax advantage of being able to claim business expenses, but also become ineligible for the Small Business Tax Deduction, losing their favorable tax rate on the first $500,000 of active income.
Historically, this issue has been (and still is) of particular concern to IT consultants. In late 2010, Peter Kovessy reported that thousands of local IT consultants faced hefty tax reassessments as the Canada Revenue Agency reexamined their relationship with staffing agencies that helped connect them to the federal government (Taxman cracks down on IT consultants, Ottawa Business Journal).
IT consultants (and other types of consultants) have basically run into the incorporation wall. If they don't incorporate, staffing agencies and corporations won’t hire them. But if they do, they may not appear "corporate enough" for the Canada Revenue Agency and face tax penalties. Some consultants, according to the article by Peter Kovessy linked above, have faced tax reassessment bills of up to $50,000 when their small business deduction claims and business expenses were disallowed. Either way, they're out of pocket.
Whether or not the Canada Revenue Agency is still pursuing an active "crackdown" on such businesses, any small business corporation that sells the services of a person to other businesses runs the risk of being viewed as a personal service business.Read more about the problem of having a Canadian personal services corporation and how you can avoid it in Being Declared a Personal Services Corporation Can Really Cost You.