Article written by Mowbrey Gil, in Canadian News Quarterly, a newsletter published by
Canadian member firms
of
Moore North America
. This article on the Canada Revenue Agency’s new direction is part of our mission to be your partner in success by keeping you informed.
Recently, theCanada Revenue Agency (CRA ) launched an “awareness project” concerning personal service businesses. In its press releases, the CRA indicated that it would be contacting Canadian companies to request documentation on potential personal service businesses, but that participation would be voluntary. However, the letters the companies received from CRA did not mention that participation was voluntary, and in fact contained references to CRA’s power to inspect the company’s records. We doubt that this new CRA initiative is purely educational, and believe that it may signal a renewed interest on the part of CRA in auditing potential personal service businesses. Against this backdrop, we wanted to take the opportunity of this article to remind you of the circumstances that can trigger the personal services business provisions, as well as their effects if triggered.
The first question you may be asking yourself is: what is a personal services business? For a company to be designated as a personal services business, three conditions must be met:
- There must be an individual performing services for a beneficiary on behalf of a company;
- This person, or someone related to him or her, must hold 10% or more of all classes of shares in the company;
- If the person provided the services directly to the beneficiary, he or she would be considered an employee of the beneficiary.
Even if the above three conditions are met, the company will not be treated as a personal services business if it meets one of the two exceptions:
- The company has more than 5 full-time employees; or,
- The service recipient is a company that is associated with the company’s service provider.
If a company is found to be in the business of providing personal services, the tax consequences can be dire. Firstly, the income of a personal services business is taxed at a higher corporate rate: these businesses cannot benefit from the general tax rate reduction or the small business deduction, and they also pay an additional 5% surtax. In Alberta, this corresponds to a total corporate tax rate of 41% and, once the proceeds are paid out as dividends to individual shareholders, an effective tax rate (including corporate and personal income tax) of approximately 60% for eligible dividends and 66% for non-eligible dividends, assuming that the top marginal tax rates apply.
What’s more, the expenses that the company can deduct are very limited: it can only deduct the salary and benefits paid to the person providing the services, the legal fees required to collect the amounts owed, and certain expenses that the person could deduct if he or she were personally providing the same services. These effects combine to create a strong disincentive to operate as a personal services business, and it is prudent to take steps to reduce your exposure in circumstances where the CRA may determine that your corporation is a personal services business.
If you have a business that provides services and are concerned that the rules that apply to a personal services business may also apply to you, please contact our tax team today.
