In certain industries, particularly the resource sector (including oil and gas), there has been a trend toward companies who wish to hire new workers, requiring those workers to first incorporate their own company (“NewCo”) to be engaged as a contractor.  The hiring company would then contract with Newco to provide the services of the worker (aka Newco’s founding shareholder and employee).

Why would a company want to hire a contractor versus an employee?  Hiring a contractor can be a lot less complicated than hiring an employee and can be less costly for the employer too! Contractors don’t generally get benefit packages or pensions and pay their own CPP/QPP contributions. As an employer of an independent contractor, you don’t have to withhold income tax or pay a share of CPP/QPP or EI.  Meanwhile, incorporation by the new worker is advantageous because it provides access to the small business deduction and the related low income tax rate, a possible deferral of income tax, limited liability, and potential access to the $750,000 capital gains exemption on qualifying small business corporation shares.

One problem, however, is that the incorporated company by the independent contractor/new worker could be considered by the Canadian Revenue Agency to be a “personal services business/corporation” (“PSB”) which can result in  many tax consequences.

“A PSB is a business carried on by a corporation where an individual who is a 10% of more shareholder of the corporation, or a person related to such a shareholder, provides personal services indirectly through the corporation to another person and “but for” the existence of the corporation, that person, the so-called “incorporated employee” would be an employee of that other person to whom he or she provides personal services”. Donald Smetheram in CLEBC Personal Services Businesses: Selected Issues and Tips to Avoid Adverse Reassessment. May 2014.

So why do you care? As in many cases – it’s the tax consequences.

The individual’s corporation, when deemed a PSB, will be prevented from claiming the small business deduction, both federally and provincially.  A higher income tax rater could also be applied.

When determining the taxable income from a PSB, the only eligible deduction for the corporation will be any salary and benefits paid to the incorporated employee (yes, that means no other expenses such as travel, office supplies and auto are allowed).

Some seem to view incorporation as “proof” of independent contractor status. While being incorporated could conceivably be one point of evidence showing an arm’s length relationship between a contractor and employer, it isn’t proof of a business relationship in itself.

If you need further advice on what the tax consequences are and how it applies to you speak to your local friendly accountant.  If you want to know how to help prevent being deemed a PSB – stay tuned to next week or contact our corporate team at Touchstone Law Group LLP.

Author: Jennette Vopicka

This information is general in nature only. You should consult a lawyer before acting on any of this information. This information should not be considered as legal advice. To learn more about your real estate needs, please contact our office at (250)448-2637 or any of our lawyers practicing in the area of estate planning at the following:

Una Gabie: una@touchstonelawgroup.com

Jennette Vopicka: jennette@touchstonelawgroup.com

Danielle (Dani) Brito: danielle@touchstonelawgroup.com