Should You Incorporate a Service Based Business?

Written by: Suzanne Cody CPA, CGA

Single shareholder corporations are probably one of the most common types of corporations created in Canada.  When making the decision to incorporate, you should be aware of the pitfall of becoming an incorporated employee.  As many contractors are finding out, tax-wise, it’s the most dangerous.  It is known as a Personal Services Business (PSB) by the Canada Revenue Agency (CRA) and the tax implications have been structured so that as far as tax deductions go, you may as well not incorporate at all!

Income from a PSB is considered not to be active business income by the CRA.  What this means is that the corporation is not eligible for the Small Business Deduction (SBD) or the Federal Abatement which are some really large tax breaks .  In Ontario that means that your corporation will be subject to an income tax rate of 39.25% compared to a small business income tax rate of 15.5% (2015 rates).   Because of this, when taking money out of a PSB by way of dividends, the final combined personal and corporate tax rate will approach 58%, which is 12% greater than a highly paid employed taxpayer  would pay.

As a shareholder in a PSB  you are deemed to be a an incorporated employee and therefore not self-employed.  The only expenses the corporation  can write off are limited to your wages and benefits, amounts expended in the selling of property if the expenses were a contractual requirement of employment, and the legal expenses of incorporation or bad debt collection.

You can avoid being deemed a PSB by ensuring that your corporation has more than five full-time employees throughout the year and/or that your corporation only provides its services to an associated corporation.

Make sure that you do not end up on the hook for a large tax bill by making this mistake.