When an Incorporated Contractor Is a Personal Services Business

What is a personal services business?

A personal services business (PSB) is a corporation's service business that meets all parts of the statutory test. The central question is whether the person doing the work would reasonably be the client's employee or officer if the corporation did not exist (Income Tax Act, section 125(7); CRA: PSB conditions).

The label applies to the service business, not automatically to every activity in a corporation. Income from a separate business needs its own treatment (Income Tax Act, section 125(7); Revenu Québec: other business expenses).

How does the CRA decide whether I would be my client's employee?

The CRA reviews the real working arrangement, including the client's right to direct the work, who supplies tools, whether the worker can hire help, and who bears financial risk. Calling the contract an independent contractor agreement does not settle the question (CRA: employment status outside Quebec).

If you left the client's payroll or were told to incorporate, compare control, tools and financial risk before and after. Incorporation alone does not make the arrangement independent (CRA: PSB pilot).

No single signal decides the case. A highly skilled worker may get little daily instruction yet still be under the client's control. Where the contract was formed in Quebec, the CRA applies Quebec civil-law factors, especially the relationship of subordination (CRA: employment status in Quebec).

Keep contracts, invoices, work schedules, emails about assignments and approval, equipment records, hiring records, and evidence of pricing or losses. They help show what actually happened, not just what the agreement says.

Does having only one client make my corporation a PSB?

One client alone does not make a corporation a PSB; client count is absent from the statutory test. A corporation with one client can be independent if the working facts support a business relationship.

Several clients do not automatically cure an employee-like arrangement with one of them. Review each substantial client relationship against the CRA's control, tools, subcontracting and financial-risk factors. The ability to seek other work is useful evidence; the actual right to accept or refuse work matters too.

What if my corporation has more than five employees or bills an associated company?

A corporation escapes the PSB definition for a business if it employs more than five full-time employees in that business throughout the year. Hiring a sixth employee near year-end does not meet the throughout-the-year condition (Income Tax Act, section 125(7)).

Amounts paid or payable for services by an associated corporation are also outside the PSB definition. The association test is a specific corporate-control test, not simply a shared customer, manager or family connection. If the contractor also bills other clients, check those amounts separately (Income Tax Act, section 125(7); CRA: PSB conditions).

These exceptions remove the PSB classification for qualifying income; they do not establish eligibility for every other tax benefit. See how Canadian corporations are taxed.

What tax rate does PSB income face?

For taxable PSB income eligible for the federal provincial abatement, the federal rate is 33%, including an extra 5% PSB tax, plus the applicable provincial or territorial general corporate rate. PSB income cannot use the federal small business deduction or general rate reduction (CRA: PSB obligations; Income Tax Act, section 124; section 123.5).

PSB status does not remove ordinary GST/HST duties; see when to register for GST/HST (CRA: PSB obligations).

The tax is on taxable PSB income, not gross invoices. The restricted deductions below can leave taxable income higher than the corporation's accounting profit. A regular Canadian-controlled private corporation's rates and business limit are covered in how corporations are taxed.

Which expenses can a PSB deduct?

A PSB may deduct only the narrow categories in Income Tax Act, paragraph 18(1)(p), to the extent they would otherwise be deductible. An ordinary business cost is not automatically allowed just because the corporation paid it.

The CRA says denied costs booked in the accounts must be added back on Schedule 1 of the T2 (CRA: T2 guide). Separate costs of another genuine business from PSB costs; the PSB restriction does not automatically attach to that other business (Revenu Québec: other business expenses).

Does paying myself a salary reduce the PSB tax?

Salary paid in the year to the incorporated employee can reduce the corporation's PSB income. It also becomes the worker's employment income, with the corporation's normal payroll, withholding and T4 duties (Income Tax Act, paragraph 18(1)(p); CRA: PSB obligations).

A dividend is a return on shares, not pay for the worker's services, so it does not replace a deductible salary (CRA: shareholder benefits and dividends). Compare the total corporate, personal and payroll effect in salary or dividends; salary is not a promise of lower total tax.

Can a professional corporation be a PSB?

Yes. The federal PSB definition does not exempt a corporation because its owner holds a professional licence. A professional's freedom in technical decisions also does not settle whether a clinic, firm or other payer controls the wider working relationship (CRA: control of professionals).

The ability to incorporate and any profession-specific ownership rules are separate questions. See professional corporations.

How does the CRA find PSBs, and what if it reassesses past years?

The CRA can compare a corporation's T2 treatment with information from the businesses that pay it, then review the underlying working facts. Its PSB pilot examined payer records and contractor returns; many confirmed PSBs had claimed the small business deduction and omitted the extra PSB tax. Those pilot findings are not a rule that any industry or contract is automatically a PSB.

Trucking has a separate reporting issue: the CRA resumed penalties for trucking payers that fail to report qualifying fees paid to trucking corporations on T4A slips (CRA: trucking compliance). A T4A helps the CRA verify income, but receiving one does not itself determine PSB status.

If the CRA reclassifies income, it can deny the small business deduction and expenses, assess the extra PSB tax, and charge interest; penalties depend on the facts (CRA: PSB obligations). It can usually reassess within three years of the original notice if the corporation was a CCPC at year-end, or four years otherwise. Extensions, waivers and misrepresentation can change that limit (CRA: reassessment periods). See reviews, audits and voluntary disclosure for responses to a CRA letter.

I claimed the small business deduction but may be a PSB: how do I fix past returns?

Review each affected year before changing a T2. The CRA permits a T2 reassessment request and points taxpayers who may have filed incorrectly to its Voluntary Disclosures Program, subject to eligibility (CRA: correct PSB filing errors).

1. Gather contracts, invoices, T4A slips, share registers, staffing records, payroll records, expense ledgers, and the original T2 returns and notices.
2. Test the statutory conditions and real working relationship for each client and year. Separate any non-PSB income and its expenses.
3. Recompute the affected T2s. For a CCPC, put PSB income after allowable related expenses on Schedule 7, Part 6, line 520. On the T2, use line 432 for a CCPC throughout the year or a substantive CCPC; use line 434 if the other general tax reduction section applies. Report taxable PSB income on line 555. Add denied expenses back on Schedule 1 (CRA: T2 guide).
4. Choose the correction route before sending returns, especially if the CRA has already contacted the corporation. See reviews, audits and voluntary disclosure.

Do not assume an earlier pilot's opportunity to correct without immediate reassessment still applies; the CRA describes that as a feature of the pilot, not a standing promise (CRA: PSB pilot).

Can I ask the CRA to rule on my PSB status in advance?

You cannot get a CPP/EI ruling on the hypothetical question of whether the client would employ you without your corporation. The CRA says CPP/EI rulings can instead decide whether you are an employee of your own corporation (CRA: PSB conditions).

An advance income tax ruling is possible for a definite proposed arrangement, for a fee, but it is not a routine status certificate. The CRA generally declines rulings driven mainly by factual determinations and generally will not rule on completed transactions. A ruling binds the CRA only for the taxpayer and facts it describes, subject to its conditions (CRA: advance income tax rulings). A written analysis of the actual relationship is usually the first step.

How does Quebec treat a PSB?

A corporation subject to Quebec corporate income tax also faces Quebec's general corporate rate on PSB income: Quebec denies its small business deduction and restricts expenses. Revenu Québec says a PSB corporation files a Quebec corporation return and may lose access to some credits (Revenu Québec: special PSB rules).

Quebec also has a separate deemed-benefit rule. A corporation carrying on a PSB now or in an earlier year may have to include an amount in income when a person incurs a debt because of the corporation's services or the individual's employment. That rule needs a fact-specific review; it is not the federal extra PSB tax (Revenu Québec: deemed benefit).

Example

Illustrative only; all amounts are Canadian dollars. An Ontario corporation bills C$100,000 for its owner's work. The client sets the owner's assignments and hours; the corporation has no other full-time employees. Assume the other PSB conditions hold, the corporation pays the owner C$60,000 in salary during the year, and it spends C$5,000 on ordinary office costs that are denied under the PSB rule.

The corporation's taxable PSB income is C$40,000: C$100,000 of fees less C$60,000 of deductible salary. The C$5,000 of office costs does not reduce that taxable income. At an illustrative 33% federal PSB rate plus Ontario's 11.5% general corporate rate, corporate tax is C$17,800 before other tax items. The owner also reports the salary personally, and the corporation handles payroll. Paying a dividend instead would not create the same corporate salary deduction (CRA: corporation tax rates; CRA: PSB tax explanation).

Different for you?

• You have not incorporated: compare the structure and PSB risk in sole proprietorship or corporation.
• Your corporation has independent contracts or another business: determine which income is PSB income and how the rest is taxed in how corporations are taxed.
• You need to choose owner pay: compare the whole corporate and personal result in salary or dividends.
• You practise through a licensed professional corporation: check the profession's corporation rules in professional corporations.
• Your client is in the US: check possible US filing and withholding in Canadian corporation US tax returns.
• The CRA has contacted you or past T2 returns used the small business rate: use reviews, audits and voluntary disclosure and gather the contracts, invoices, T2s, payroll records, expense details and notices for each year.
• Your status depends on disputed working facts or several years: seek corporate tax preparation with the client contracts, share register, staff count and evidence of who directed the work.