When contractors are engaged to provide services through their own corporation, it isn’t always as simple as “you’re an independent business.” In some cases, the Canada Revenue Agency (CRA) considers such arrangements to be a Personal Services Business (PSB) — a classification that carries very specific tax implications for both the contractor and their corporation.
What Is a Personal Services Business?
A Personal Services Business exists when a corporation provides services where:
- The person delivering the work is a specified shareholder of the corporation (often called an “incorporated employee”), or
- A relative of that incorporated employee is involved; and
- The nature of the working relationship with the entity receiving the services could reasonably be viewed as an employee/employer relationship.
In simpler terms: if you would normally be considered an employee of the client were it not for the fact that you have incorporated yourself, your corporation may be treated as a PSB under the Income Tax Act.
Important Exception:
If your corporation has more than five full-time employees during the year, it usually won’t be treated as a PSB.
Why It Matters: Tax Consequences of Being a PSB
Being labelled a Personal Services Business can significantly affect your tax situation. Two main differences stand out:
1. Limited Expense Deductions
PSBs face strict limits on what they can claim as expenses. Generally, only the following costs can be deducted:
- Wages, salary, or remuneration paid to the incorporated employee
- Costs of benefits or allowances provided to that employee
- Amounts spent on activities like selling corporate property or negotiating contracts, if those amounts would have been deductible had they been incurred by the worker directly under a contract of employment
- Legal fees related to collecting amounts owed for services rendered
If a typical business could claim certain costs but your PSB cannot, your net income — and thus the tax you owe — may be higher.
Higher Corporate Tax Rates for PSBs
Unlike most small Canadian corporations eligible for lower tax rates, a PSB cannot claim the small business deduction or the general rate reduction. These exclusions mean:
- PSBs pay higher corporate taxes than other types of businesses.
- Corporate profits that remain in the company may be less tax-efficient than if distributed as salary because of this higher tax burden.
As a result, PSB owners often need to closely evaluate how they compensate themselves and manage profits within the corporation to optimize overall tax outcomes.
CRA’s Focus on PSBs and Investigations
In recent years, the CRA has increased its attention on PSBs — particularly where companies require workers to incorporate and then provide services that resemble an employment relationship. This can sometimes be an attempt by some employers to reduce their own payroll costs, such as employer contributions to Canada Pension Plan (CPP) or Employment Insurance (EI).
Budget changes have even expanded the CRA’s ability to share information with other government departments to address what’s known as “worker misclassification.” This means the CRA has more tools to identify situations where a corporation is effectively acting as a disguised employment relationship rather than a true independent business.
Steps to Reduce Your PSB Risk
There are practical actions contractors can take to help demonstrate that their business operates independently and is not a Personal Services Business:
- Use clear, well-structured contracts that define your role, responsibilities, and scope of work, and have them reviewed by professionals familiar with PSB rules.
- Present a professional business image by operating under a distinct business name and maintaining separate contact details that reinforce your status as an independent company.
- Carry business liability insurance, which helps establish that your corporation assumes its own commercial risk rather than functioning as an internal worker.
- Maintain control over how work is performed, ensuring clients define deliverables and outcomes rather than directing the day-to-day execution of your tasks.
How We Help Protect Clients from PSB Classification
At CPA4IT, we help reduce the risk of our clients being classified as a Personal Services Business by the CRA. Our team works closely with clients to assess PSB exposure, strengthen their independent contractor position, and put proactive safeguards in place. This includes reviewing contracts, advising on business structure and operations, and ensuring documentation supports a true business-to-business relationship. Our goal is to help clients preserve access to small business tax benefits and avoid the costly consequences of PSB reassessment. Book a FREE consultation today to learn about how we can help you organize your finances, create wealth, and transform wealth into a legacy.
Final Thoughts
For incorporated contractors and consultants, the PSB rules are one of the most important — and potentially costly — tax classifications under Canadian tax law. If your business might fall into the PSB category, it’s crucial to understand both how it’s defined and how it could affect your taxes.
Assessing your contracts, corporate structure, and compensation strategy with a tax professional can help ensure your business is taxed appropriately and that you’re not unintentionally landing in a higher tax bracket simply because of how your corporation is structured.
