Can An Employee Be Incorporated?

Can An Employee Be Incorporated

What is a Personal Services Business?

A person services business (PSB) is a business operating as a corporation that provides services to other entities in which an employee or officer of that entity may traditionally perform. In lay-mans terms, it is an incorporated employee and for some employees, incorporation may prove beneficial.

The CRA has clearly set out what type of income is classified as “PSB income”. Income earned by the incorporated employee i.e. the corporation will be PSB income in the following situations:

(a) Where the corporation is performing the services or any person related to the corporation/incorporated employee, is a designated shareholder (i.e. a taxpayer who is owning, directly or indirectly during the year, a minimum of 10% of issued shares of any class of the corporation or related corporation) of the corporation

(b) Were it not for the corporation, the incorporated employee will reasonably be considered to be an officer or employee of the entity purchasing and receiving services from the corporation.

Two exceptions exist where a corporation will be refused PSB status by the CRA. The first is if the employees of the corporation are greater than five full-time employees or if the corporate entity is providing services to an “associated” corporation. If any of these circumstances are present, income will not be from a personal services business and will therefore, be eligible for the small business deduction.

Consequences of a PSB

The CRA put in place PSB rules to discourage the incorporation of employees and to prevent tax advantages to employees who formed a corporation.

Some of the greatest issues with operating a PSB are that the small business deduction is not allowed. Deductions for computing PSB income is restricted to salaries and wages, costs of other benefits/allowances given to the incorporated employee and some expenses of the corporation related to selling property and contract negotiation. If you are a PSB, the first $500,000 of corporate income will be taxed at the higher personal rate instead of the lower corporate tax rate. If your corporation is classified as a PSB, tax penalties may be instituted against your corporation because of incorrect misclassification when filing your corporate taxes.

In deciding whether one is operating as a PSB, it is important to consider the factors used in distinguishing employees versus contractors such as the degree of control exercised by the hirer, who provides the tools used to perform the services, whether there is opportunity for profit for the contractor and the degree to which the contractors work is integrated with the hirers business.

Furthermore, it should be noted that a PSB that pays wages or salaries should be cognizant of withholding and reporting responsibilities. If the corporation is not clearly a PSB, the employer should pay the contractor as an employee and make the requisite CPP contributions and source deductions.

Employment lawyers should be careful to advise on the risks and benefits associated with a PSB especially if the incorporated employee is providing services to one company. Employment lawyers should advise on the income tax implications of these long-term service contracts. Stacey Reginald Ball is a Toronto employment lawyer versed in the legal implications associated with a PSB. For a consultation, please call our office at 416-921-7997.

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