Updated Checked by the Tax-Services.ca editorial team How we check
A personal services business is a corporation that does what an employee would do for one payer, and the CRA treats it harshly. It can’t claim the small business deduction or the general tax reduction, it is limited in the expenses it can deduct, and it pays an additional 5% tax. That’s the answer to why people worry about it.
The rules target one specific setup, so start by checking if yours is that setup.
What makes a corporation a personal services business?
The CRA lists five conditions, and they all have to be true in the same year. You provide your work through a corporation. You, or someone related to you, is a specified shareholder of it. The corporation has five or fewer full-time employees throughout the year. The money it earns for those services doesn’t come from an associated corporation. And if the corporation didn’t exist, you’d reasonably be seen as the payer’s employee.
The last condition is the one that decides most cases. It’s a judgement about the working relationship, not a box you tick. The CRA points to its employment status factors for that test, and we haven’t tried to summarise them here. Its page on what a personal services business is is the place to start.
What does a personal services business cost you?
Three things, according to the CRA. Income isn’t eligible for the general tax reduction or the small business deduction. The corporation is limited in which expenses it can deduct. And there is an extra 5% tax on top.
| Feature | Ordinary small corporation | Personal services business |
|---|---|---|
| Small business deduction | Available, up to the limit | Not available |
| General tax reduction | Available | Not available |
| Additional tax | None | 5% |
| Expense deductions | Normal business rules | Restricted |
A simple case. If the corporation earns $100,000 that counts as personal services business income, the extra tax alone is 5% of it, so $5,000. On $60,000 it would be $3,000. That’s before the lost federal rate reductions, which the CRA doesn’t put a dollar figure on for us. We didn’t calculate the full bill, because the answer changes with the province and with which deductions get denied.
Are you an incorporated employee or a real contractor?
Most contractors aren’t in trouble. If you have several clients, use your own tools, set your own hours and take a real chance of loss, you probably would not be seen as an employee without the corporation. One client and one desk are the warning signs, and the same job for the same employer you had last year, now on an invoice, is hard to argue is anything but employment.
Picture Fatima, a developer in Mississauga. She incorporated last spring, then went back to her old employer as a “contractor” on the same team, same laptop, same hours, with the same manager. On paper she’s in business. In practice, ask yourself whether anything changed besides the invoice. If not, that’s the pattern the rules aim at.
Two exits exist in the rules themselves. A corporation with more than five full-time employees throughout the year isn’t caught. Neither is one whose services are paid for by an associated corporation. Hiring a few part-timers to get there won’t do it, because the rule says full-time.
What should you do if you think you might be one?
Look at your contracts first. Ask what your client controls, who supplies the equipment and who bears the losses. Then run the numbers both ways. The corporate tax calculator models an ordinary corporation, so use it as the best case, not as a forecast for a PSB. The self-employed tax calculator shows the sole proprietor route, and the payroll deductions calculator shows what being on payroll would look like.
If the money then comes out of the corporation as dividends, the dividend tax calculator estimates the personal tax. Where the contract is grey and the amounts are large, an accountant who does incorporated contractors is worth the fee, because the classification is a legal judgement.
What mistakes and limits apply here?
The common one is assuming that incorporating changes the relationship. It doesn’t, since the test looks through the corporation. Another is forgetting that a former employer is often the only client after you incorporate. A third is assuming that a signed contract calling you an independent contractor settles it. The label matters less than how the work is really done.
Our summary uses the CRA’s pages on what a PSB is and on how to determine one. It doesn’t cover the tax treatment of specific expenses or provincial rates, and the details of each condition have exceptions. Read the CRA page for the year in question before you act on it. If you’re just starting out and weighing incorporation, our self-employed and small business guide gives the wider picture.
The sources behind this page
The definition, the five conditions and the tax consequences come from the Canada Revenue Agency‘s pages on personal services businesses. The $5,000 and $3,000 figures are our own arithmetic on the 5% rate. We’re an independent site, not a tax adviser, and nothing here is advice on your case.
Frequently asked questions
What is a personal services business?
A corporation whose worker would reasonably be seen as the payer's employee if the corporation didn't exist, and that meets the other CRA conditions.
What extra tax does a personal services business pay?
The CRA says an additional 5% tax applies, and the corporation can't claim the small business deduction or the general tax reduction.
How many employees take a corporation out of the rules?
More than five full-time employees throughout the year. Five or fewer keeps that condition in place.
Does working for an associated corporation count?
Money paid by an associated corporation means the corporation is not caught by these rules, per the CRA's conditions.
Who decides if I am an incorporated employee?
The CRA applies the employee test to the actual working relationship. Your incorporation status doesn't settle it.
- Self-employed taxes in Canada: income, CPP and GST
How tax works when you are self-employed in Canada: reporting income and expenses, paying both halves of CPP, instalments and when to register for GST