by Harold J. Feder of BrazeauSeller LLP
Before anyone’s mind starts to wander, the term “Personal Services Business” is simply a term defined under theIncome Tax Act Canada. Without going into the technical details of the definition, it essentially means a business carried on by a corporation where the services performed by the corporation are provided by an individual who would otherwise be considered an employee of the recipient of the services. The individual in this situation is often referred to as an “incorporated employee”.
In the classic example, an employee of a corporation leaves employment and then starts a corporation to provide services to his or her former employer. The motivation behind this structure is to take advantage of the small business deduction rate for Canadian controlled private corporations and the numerous deductions available to a corporation, as opposed to an employee.
Back nearly thirty (30) years ago, in an effort to curb these arrangements, the Department of Finance enacted legislation to deal with income earned by a personal services business. The effect of the original legislation was to deny the small business deduction as well as the deduction of most ordinary expenses. The result was that the incorporated employee would be taxed at the higher corporate tax rate and would have most expenses disallowed. At the end of the day, this legislation was punitive in that it put the individual in a worse after-tax position than they would have been had they earned the employment income directly.