PSB PERSONAL SERVICE BUSINESS Tax penalties for oneman corporation Working More Than 2 Years With Same Company, At The Same Pos

My question is: Canadian-specific

QUESTION:

I am providing a consulting services to a client through a third party/headhunter, means my client where I actually work doesn't directly pay me, she pays to the Headhunter/personal resources company, then they pay to my Company and my Company pays me …. I have been working for the same client almost 2 years, and my client wants to renew my contract to another 6-12 months, but they are saying per Canada Revenue, "A contract worker can't work on the same position more than 2 years", so the only way that I can renew my contract is, if I just work till end the end of my current contract and then work some where else for 4-5 months, and then I can come back and can work on the same position as a contractor
My questions: First, is there such a rule per CRA, second would that rule apply to my situation, where all payment transactions are made between the Incorporated companies; no one directly pays to me but my own Incorporated company..

Thanks


david ingram replies:

You are caught in the Personal Service Business rules. These apply at "any" one time - I do not know of a two year rule but I may have missed it. In my opinion, based upon your question, a corporation does you no good anyway "IF" your returns have been done properly. In fact, if you have a corporation, you can not make your mortgage interest deductible as easily.

What is a PSB?

A business carried on by a corporation will generally be a PSB if the following two tests are met:

1. The individual performing the services (or someone related to the person) owns 10% or more of any class of shares of the corporation, and


2. Without the use of the corporation, the individual would reasonably be regarded as an employee of the person or partnership paying a fee to the corporation.


The key test is really - are "you" an "incorporated employee"?

The CRA will look at in determining whether an individual is an incorporated employee using the following criteria:

Who is an Incorporated Employee?

The issue of whether someone is an incorporated employee is a question of fact dealt with on a case-by-case basis.

Answering yes to the following questions would be indicative of an "incorporated employee" relationship with a client:

* Are there very few clients, or worse, only one client?
* If you only have one or two clients, do you carry on the duties at the client's offices on a regular and continuous basis?
* Does your client provide an office and tools of the trade such as a computer or service truck?
* Does your business card have your company name or the client's name on it?
* Do customers of the client think of you as an employee of the client or are you an obvious business on your own?

* Does the client pay you on a regular basis, without the submission of an invoice?
* Is your name on the client phone directory?
* Would you appear to be an officer or employee of the client to a third party?
* Are you remunerated on an hourly fees basis irrespective of the time needed to accomplish the task?
* Were you hired to perform ongoing services as opposed to completing specific projects?
* Are there expected hours of work that are to be put in each day?
* Are you allowed to send someone else to do your duties or must all services be performed by you (that is, would the client not allow you to provide a substitute or not allow you to subcontract your duties)?
* If supplies or equipment are needed to complete a task, are they provided by the client?
* Will the client absorb any risk should a project go over budget or do you take the risk of completion?


There is an exception for corporations having more than 5 full-time employees, and for services provided to an associated corporation (since these two corporations must share one small business deduction regardless).


How is PSB Income Taxed?

When a corporation is carried on by a PSB, there are two main tax consequences:

* The corporation will be prevented from claiming the small business deduction, both federally and provincially.

* When calculating income from the PSB, the eligible deductions will be restricted to:


1. Remuneration and benefits for the incorporated employee;


2. If the incorporated employee is a salesperson receiving commissions, expenses paid by the corporation that would have been allowed as a deduction to the individual personally as a commissioned salesperson had he/she incurred the expense; and


3. Legal expenses incurred by the corporation in collecting amounts owing to it on account of services rendered.

The PSB is NOT eligible for the small business deduction. Therefore tax can end ip being higher using a PSB one person corporation working for one entity than if you just worked as an employee with no benefits - i.e. no EI, etc.

Worse yet, is that the CRA can come along three years later and re-assess several years at once leaving you with massive tax and interest bills.

I do not know of any two year rule about hiring a one person corporation.

However, they have likely done you a favour in pointing this out.

At a $100,000 year profit, the tax is about $10,000 "higher" if you pay the profit to yourself as a dividend and the CRA reverses it as a one person corporation with one client than it is as a straight salary "IF" the corporate tax return is done correctly. In BC, the difference is $10,000 a year.

The US is no better by the way. A one or two person corporation is usually an "S" Corporation where all profits flow through to the shareholder at their personal tax rates.

If you offer your services to a small number of businesses, you need to decide with each one if you are an employee or self-employed.

If you incorporate, the stakes are very high - if you are a true self-employed contractor, you might be able to benefit from a lower tax rate provided by the small business deduction. However, if it turns out that you are an incorporated employee, the tax cost will also multiply,

Remember that the reason for the small business tax rate is so that the small business can buy machinery, a new truck, etc. It is not so that "George" will pay less tax. If the CRA reclassifies you, the tax penalty is HUGE! From your description, you would be reclassified.

As I said at the start, the other problem is that with a corporation it is hard to make your mortgage interest deductible. Go to www.centa.com and read the November 2001 Newsletter in the top left box.

This is a great question for the Sunday Morning Radio Show.