The Personal Services Business income rules are intended to prevent employees (or at least limit any tax benefits) from ceasing their employment, incorporating and then providing the same services back to their former employer through an incorporated company.
Personal services business income is taxed at the full corporate rate plus an additional 5% surtax. This income is not eligible for the Small Business Deduction or the General Rate Reduction. According to ITA 125(7), a corporation falls under a personal services business if it meets the following criteria:
- Income is earned through services provided by an individual on behalf of the incorporated employee.
- An individual who provides services on behalf of the corporation, or any person related to the incorporated employee, is a shareholder of the corporation.
- Does not hire more than five full-time employees throughout the year.
- “The services of the corporation are not being provided to an associated corporation.” (BDO, 2018)
- Incorporated employee is regarded as an officer/employee of the person to who the services are provided.
To be classified as a personal services business is not a favourable outcome for tax purposes. As mentioned earlier, a personal services business is not eligible for the small business deduction or the general rate reduction to 13% and, in fact, gets an additional 5% surtax.
Furthermore, under ITA 18(1)(p), deductions for a personal services business are severely limited to the wages and benefits to the “incorporated employee” and similar costs that would be deductible if that individual had remained a regular employee. Ultimately, the ITA says “fine, you incorporated, but you are going to be taxed at a really high rate on your income and you aren’t going to have access to many business deductions”