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Back in 2009, I had written an article about setting up a personal service corporation. The article included comments on the possible income tax impact if the corporation was considered to be carrying on a “personal service business” (“PSB”). Briefly, a corporation that provides a PSB is essentially providing the services of an “incorporated employee”, where the incorporated employee would otherwise reasonably be regarded as an officer or employee to the entity receiving those services. See the article here for more details.
New rules introduced in 2006 reduced the income tax impact for a PSB corporation, and made it easier to allow for some tax planning, such as income splitting with family members. Those changes resulted in a proliferation of arrangements where a business wanted to hire someone as an independent contractor, but the contractor was reluctant to set up a corporation to provide his or her services. With the changes, it became easier to set up a corporation for that purpose, even if the PSB rules applied, since income splitting with family members became more feasible.
But the changes also resulted in CRA auditing more companies that were set up to provide personal services, and were reporting the income as regular business income eligible for the small business deduction, which reduced corporate taxes considerably. Auditing such corporations became a fairly significant undertaking for CRA, with a number of them being challenged by the contractor, and often winding up in court.
Well, the rules regarding a corporation carrying on a PSB just became a lot more expensive, tax-wise. On October 31st, the Federal Government came out with proposed changes that essentially increase the income tax for any corporation that provided a PSB. What’s worse, those proposed changes are effective for any fiscal year that begins after that date.
For example: if you have a corporation that is affected, and its year-end is November 30, 2012, the new rules affect all of the income for that year. Talk about a nasty trick on Halloween.
To give you an idea of the impact, in 2012, a contractor who was hired personally would pay a maximum tax rate of 39.0% in Alberta. If a PSB corporation was used instead, and the income was reported by the corporation and paid out as “eligible dividends”, the maximum combined corporate and personal taxes would have been 39.5%.
The proposed changes would now result in the combined corporate and personal taxes in Alberta becoming 50% for 2012. Similar increases apply for other provinces, see your local MNP Tax advisor for the increases in your province.
Well, here are some options to consider.
While the proposed rules increase the PSB risk and tax cost for the contractor, the entity that uses those services could also have problems.
For example: could the contractor argue that the arrangements were only undertaken under duress?
That has its own separate legal problems, which are beyond the scope of this blog, and have to be addressed by a lawyer.
Suffice it to say that the whole area of using independent contractors will have to be revisited, if the contractor is using a corporation.
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This blog post has been prepared for informational purposes only and is not intended for any other purpose. We do not assume any responsibility or liability for losses occasioned by you in reliance on this information. We would be pleased to discuss with you the issues raised within the context of your particular circumstances.
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