Personal Services Business (PSB) in Canada: Are You Really an Employee in Disguise?
Many incorporated contractors in Canada assume that setting up a corporation automatically shields them from higher taxes. But if the Canada Revenue Agency (CRA) considers your corporation a Personal Services Business (PSB), the story changes. In fact, a PSB can lead to some of the highest tax rates in Canada, catching many business owners off guard.
So, what exactly is a PSB, and how do you know if you’re at risk of being classified as one? Let’s break it down.
What is a Personal Services Business (PSB)?
A Personal Services Business (PSB) is a corporation set up by an individual—often a consultant or contractor—who essentially provides services to a client that resemble the work of an employee.
In other words, if you run your business through a corporation but would be considered an employee if not for that corporation, the CRA may classify your corporation as a PSB.
Why Does the CRA Care?
The CRA introduced PSB rules to prevent employees from incorporating just to take advantage of lower small business tax rates. Being a PSB means:
You don’t qualify for the small business deduction.
You lose access to many corporate tax deductions.
Income may be taxed at much higher rates (upwards of 40%+).
How Does the CRA Determine PSB Status?
The CRA looks at the true nature of your working relationship with your client. Some of the key factors include:
Control: Does your client control how, when, and where you do your work?
Tools and Equipment: Do you use the client’s equipment, or do you bring your own?
Risk of Profit or Loss: Do you bear any financial risk, or are you paid like an employee regardless of results?
Integration: Are you an integral part of the client’s business, similar to an employee?
Number of Clients: Do you work with multiple clients, or rely on just one?
If most of these point to an “employee-like” relationship, you’re at risk of being a PSB.
Tax Consequences of Being a PSB
Being classified as a PSB can be costly:
Higher corporate tax rate: Around 33% federally (plus provincial rates).
Loss of business deductions: You can only deduct limited expenses (like salary paid to yourself, legal fees, or certain benefits).
Double taxation risk: If you withdraw income as dividends, you may face even higher personal tax rates.
How to Avoid Being a PSB
While there’s no guaranteed way to avoid PSB classification, you can reduce your risk by:
Diversifying your client base instead of relying on one client.
Having a clear contract that defines you as an independent contractor.
Using your own tools and equipment where possible.
Showing business risk (e.g., fixed-price contracts, subcontracting work, investing in marketing).
Paying yourself a salary instead of dividends to reduce the tax hit if you are classified as a PSB.
Final Thoughts
The Personal Services Business (PSB) rules in Canada are designed to ensure fairness in the tax system, but they can catch many incorporated contractors by surprise. If you’re concerned that your corporation might be at risk of being considered a PSB, it’s crucial to review your contracts, working arrangements, and overall business structure.
Speaking with a tax professional can help you understand your exposure and create a plan to reduce the risks of higher taxes.
