Personal service businesses, also known as PSBs, are a type of business that provides services that are primarily of a personal nature. These businesses are often subject to different tax rules than other types of businesses. In this article, we will discuss everything you need to know about personal service businesses in Canada.
What is a Personal Service Business?
According to the Canada Revenue Agency (CRA), a personal service business is a business that primarily provides services by an individual who owns, either directly or indirectly, a share of the corporation that provides the services. The individual who provides the services is called an incorporated employee.
The CRA defines a personal service business as any business where the incorporated employee would be considered an employee of the client, rather than an independent contractor, if the corporation did not exist. This means that if the incorporated employee was not incorporated and was providing services as an individual, they would be considered an employee of the client.
Examples of personal service businesses include consulting firms, law firms, accounting firms, and medical practices.
Tax Implications of Personal Service Businesses
Personal service businesses are subject to different tax rules than other types of businesses. The main reason for this is to prevent individuals from incorporating themselves in order to take advantage of the lower corporate tax rates.
One of the main tax implications of a personal service business is the loss of the small business deduction. This deduction allows small businesses to pay a lower tax rate on their first $500,000 of active business income. However, personal service businesses are not eligible for this deduction.
In addition, personal service businesses are subject to a higher tax rate on their passive income. Passive income is income earned from investments, such as interest, dividends, and rental income. The higher tax rate is meant to discourage personal service businesses from using their corporation as a way to shelter investment income from personal taxes.
How to Determine if Your Business is a Personal Service Business
If you are unsure whether your business is considered a personal service business, the CRA provides a list of factors to consider:
- Does the corporation have more than five full-time employees who are not related to the owner(s) of the corporation?
- Does the corporation own significant assets, such as buildings or equipment, that are used in the business?
- Does the corporation have multiple clients?
- Does the incorporated employee have control over their work, such as when, where, and how they work?
- Does the incorporated employee provide their own tools, equipment, or supplies?
- Does the incorporated employee have the ability to hire their own assistants?
- Does the corporation assume any financial risk, such as liability insurance, bad debt, or warranty obligations?
- Does the corporation have any intellectual property, such as patents, trademarks, or copyrights?
If your business meets some or all of these factors, it may be considered a personal service business.
In conclusion, personal service businesses in Canada are subject to different tax rules than other types of businesses. If you own a personal service business, it is important to understand these rules in order to avoid penalties and ensure compliance with the CRA. If you are unsure whether your business is considered a personal service business, it is recommended that you consult with a tax professional for guidance.