What is a personal services business and how do I avoid PSB status?

The test the CRA actually applies

The core question behind a personal services business is whether the individual doing the work, if the corporation were removed from the picture entirely, would look like an employee of the person or company paying for the services, rather than an independent contractor. The CRA and the courts look at the same factors used in any employee-versus-contractor analysis: who controls how, when, and where the work gets done; who owns the tools and takes on financial risk; whether the worker can profit from efficiency or absorb a loss; and how integrated the worker is into the client’s operations. A corporation set up around a single person providing services to one client, on that client’s schedule, with that client’s equipment, is the classic PSB fact pattern.

The specific carve-outs in the definition

Two conditions can keep a corporation out of PSB status even if the underlying relationship otherwise looks like employment: employing more than five full-time employees throughout the year, or providing the services to a corporation with which it is associated. Most one-person consulting or contracting corporations do not meet either exception, which is why the employee-versus-contractor factors end up doing most of the work in a real PSB determination.

What it actually costs to be classified a PSB

The tax consequences are meaningfully worse than simply losing a discount.

• No small business deduction. None of the corporation’s income from the PSB relationship qualifies for the small business rate discussed in what is the small business deduction, regardless of how small the corporation is.
• An additional federal tax. A specific additional tax applies on top of the general corporate rate for PSB income, pushing the federal component alone to roughly 33% as at the time of writing, before Ontario’s general rate is added.
• Almost nothing is deductible. A PSB can generally only deduct the salary and benefits actually paid to the incorporated employee and a narrow list of other costs, losing the ability to deduct the broader range of expenses an active business would normally claim.

Put together, a corporation reclassified as a PSB after the fact, typically on audit, can face a materially higher tax bill for years already filed, plus interest, on income the owner assumed was being taxed at the small business rate all along.

The CRA has been actively looking at this

The CRA has run targeted outreach and review campaigns, including letters sent to incorporated individuals whose fact pattern resembles a PSB, particularly in fields like IT consulting where a single worker frequently contracts long-term through a staffing intermediary to one end client. Receiving one of these letters is not itself a reassessment, but it is a signal that the specific relationship is worth reviewing carefully rather than ignoring.

Why this trap catches capable, well-meaning owners

Most people who end up with a PSB did not set out to misuse a corporation. A common path is a long-tenured employee who is laid off, then rehired by the same employer as an incorporated contractor doing essentially the same job, at the same desk, on the same schedule, because it suited the employer's staffing needs at the time. Nothing about that arrangement was dishonest, but nothing about it changed the substance of the relationship either, and the corporation sitting between the worker and the paycheque does not change how the CRA analyzes the underlying facts. This is exactly the fact pattern a PSB review targets, regardless of how the arrangement came about. The lesson is not that incorporation was the wrong choice, it is that the working relationship itself, not just the paperwork wrapped around it, has to actually look independent for the corporation's tax treatment to hold up.

How to reduce the risk of PSB classification

None of the following guarantees a corporation avoids PSB status on its own, since the CRA and courts weigh the whole relationship together, but each factor genuinely moves the analysis in the right direction.

• Multiple clients. A corporation that serves several clients, even a few, looks far less like a single employment relationship than one tied to a sole client year after year.
• Control over how the work gets done. Setting your own hours and methods, rather than working the client’s shift on the client’s terms, supports independent contractor status.
• Providing your own tools and equipment where practical for the type of work, rather than using only what the client supplies.
• Carrying genuine business risk, such as fixed-price engagements where profit depends on efficiency, rather than being paid purely for hours worked with no downside.
• Looking like a business in the ordinary sense: a business number, invoicing, a website, insurance, and a contract that describes an independent services relationship rather than an employment relationship in substance.

Consultants working through IT staffing arrangements face this issue especially often, since the contractual chain of agency-to-client can still leave the worker looking, in substance, like an employee of the end client. We cover the industry-specific version of this on our IT consultant tax services page.

How we handle this

We review a new incorporated client’s actual working relationship, not just the paperwork, before assuming the small business rate applies, and we flag a PSB risk early enough to adjust the arrangement, add clients, or change how the contract is structured before a CRA review forces the issue. This is part of our corporate tax services for incorporated consultants and contractors.

Source: CRA — Personal services business.