PERSONAL SERVICE BUSINESS - Dangers for Independent Contractors
Contact our law firm for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Many companies look to hire independent contractors who operate as an incorporated company, yet if the Canada Revenue Agency views the arrangement as a Personal Services Business and take punitive action, even though the hiring company is insistent that the independent contractor be incorporated. Independent contractors, therefore, need to be aware of the possible repercussions of being adjudged to be conducting a Personal Service Business, so that they may take steps to limit its possibility, as well as dealing with an adverse determination. In the eyes of the Canada Revenue Agency (CRA), a Personal Services Business (PSB) essentially exists when an individual provides services through a corporation but would be considered an employee of the hiring entity if the corporation were removed from the equation. This "incorporated employee" status often arises in industries like IT, trucking, and construction, where workers may feel like independent business owners but functionally operate under the direction and control of a single client.
To determine if a corporation is operating as a PSB, the CRA applies a test based on four primary factors: control, ownership of tools, chance of profit/risk of loss, and integration. If the hiring company dictates your hours, provides your equipment (like laptops or software), and you face no real financial risk (such as the possibility of losing money on a contract), the CRA is likely to view you as an employee rather than an independent business. "Integration" refers to how woven your role is into the client's organization; if you attend regular staff meetings, manage their employees, or appear on their internal phone directory, it signals that your services are integral to their business rather than a separate, arm's-length service.
The financial repercussions of a PSB designation are severe and punitive. Unlike a standard small business that benefits from the Small Business Deduction (resulting in a corporate tax rate of approximately 12.2% (Ontario) or 11% (Alberta)), a PSB is denied this deduction and faces a much higher tax rate, often exceeding 44% when federal and provincial rates are combined. Furthermore, the vast majority of standard business deductions, such as vehicle expenses, home office costs, and meals, are disallowed. A PSB is strictly limited to deducting the salary and benefits paid to the incorporated employee, leaving the remaining corporate income exposed to these prohibitively high tax rates.
To limit the possibility of this designation, independent contractors must actively structure their working relationships to reflect true business independence. The most effective defense is diversifying your client base; having multiple clients demonstrates that you are not economically dependent on a single entity. Additionally, your written contracts should explicitly define the project-based nature of the work, allowing you the right to subcontract duties or hire assistants. In practice, you should maintain your own liability insurance, use your own equipment, and invoice for completed deliverables rather than merely trading time for money. It is crucial that your actual working reality matches the contract; a "label" of independent contractor in a document offers little protection if your daily routine mirrors that of an employee.
If you are faced with an adverse determination where the CRA assesses your corporation as a PSB, you have specific avenues for recourse. You have the right to file a Notice of Objection within 90 days of the Notice of Assessment if you believe the ruling is factually incorrect. This process initiates a formal review by the CRA’s Appeals Division. If the designation is upheld, the primary mitigation strategy is often to pay out the corporation’s income as salary to the incorporated employee. Since salary is one of the few deductible expenses for a PSB, this reduces the corporation's taxable income to zero, shifting the tax burden to your personal income tax return and avoiding the punitive corporate tax rates, though this may trigger interest and penalties on unremitted payroll deductions for past years.
At Neufeld Legal, we have the experience and insight to assist you in commencing as an independent contractor, from the establishment of your corporation to reviewing and advising on business contracts. Contact our law firm to incorporate a new corporation or address legal matters pertaining to your commercial pursuits as an independent contractor at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
