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2015_February_Business_Matters_Newsletter

In this issue you will find articles on:

  • Income Tax Fraud
  • USB Thumb Drive Technology
  • Preparing for an Orderly Exit
  • Moving Inventory

Click on the above link above to access the newsletter.

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Small Business Deduction – not everyone qualifies

The CRA has yet again won a court case where two corporate taxpayers were claiming the small business deduction only to have it denied as each company was found to be ‘personal service business’ (see 1165632 Ontario Limited, 2014 DTC 1184).  This is important because the combined corporate tax rate in Ontario at the time of this writing is 26.5% unless the company qualifies for the small business deduction, then it drops to 15.5% – that is an 11% lower tax bill.  A personal service business does not qualify for the small business deduction.  Further, the expenses a personal service business are allowed to deduct are very restricted, generally limited to only those items that an employee could deduct (i.e. home office, use of auto, …).  Lastly, a company that does not qualify for the small business deduction also does not qualify for the lifetime capital gains exemption on qualifying small business shares, currently $800,000.

Subsection 125(7) of the Income Tax Act defines a “personal services business” to be a business of providing services being carried on by a corporate taxpayer through an employee who could be reasonably regarded as an officer or employee of the person or partnership for whom the services are being provided, but for the existence of the corporate taxpayer.

The issue, therefore, is whether a person would have been an employee of the  client company (“ClientCo”) if that persons company (“ConsultCo”) did not have any agreement or management contracts with ClientCo. Determining the existence of an employer-employee relationship requires an analysis of certain factors associated with that relationship (i.e., control, tools, opportunity for profit, and risk of loss; see Wiebe Door Services Ltd. v. MNR, 87 DTC 5025 (FCA)). Applying these factors to the person’s relationship with ClientCo, if the conclusion is that the person would have been an employee of ClientCo if Clientco’s business management contracts had not been with the ConsultCo but with the person directly then ConsultCo is a “personal service business”.

 It is always a good idea to sit down with your tax professional, such as Numbers Plus Professional Corporation, to have a detailed discussion of your plans and consideration to issues such as this need to be taken into account.

 

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A Personal Service Business is a structure where a person sets up their own corporation (“PSBco”) and then provides services to another corporation. If it weren’t for their PSBco they would be considered an employee for tax purposes.  This is a structure that has been specifically targeted by both the Federal and many Provincial Governments to make this arrangement unattractive from a tax perspective.  Unlike most small businesses a PSB is not allowed to get the small business tax rate on the first $500,000 of earnings, and can often end up paying more tax than if they really were an employee.  This ‘carrot and stick’ approach is to encourage the owner of the PSBco to pay all income out as salary as that is the only way to bring the tax payable down.  Note: PSBco’s cannot deduct most business related expenses that any other corporation could – the allowed deductions are really limited to just those items that an employee can deduct on their personal tax returns.  Further, being self employed the now business owner loses things like Employment Insurance coverage, Employment Standards Act protections (i.e. no rights to for Severance or vacation pay) and now will be paying twice the usual amount for CPP and likely will have to pay premiums for WSIB on their earnings.

 

I was reading a recent report from the Canadian Tax Foundation and there was an interesting article written by a tax lawyer named H. Michael Dolson of Felesky Flynn LLP, Edmonton  titled “Stop PSB Proliferation”, Canadian Tax Highlights, vol. 22, no. 9 (Canadian Tax Foundation) (September 2014). Although I enjoyed the entire article there is one paragraph that Mr. Dolson wrote that I found to sum up PSBco’s very well.   “The fact that PSBcos are apparently becoming more common is ultimately a reflection of the power imbalance between workers and employers and the inaccurate information provided to individuals. The payer can circumvent substantially all the hard-won rights and protections for workers created during the 20th century without any corresponding benefits for the workers. Finance’s and Parliament’s approach produces an inequitable and unjust result: it imposes punitive tax consequences on the party that has less bargaining power.

 

What you should know is the government is aware that there are more and more PSBco’s out there and many of them are not paying the correct amount of tax and have become an increasing target for CRA audit, complete with findings of large amounts of tax owing, plus interest and penalties.  According to Statistics Canada, between 2000 and 2008 47.7 percent of companies created had one or less labour unit in their second year of operation – which is one of the ‘red flags’ that the company **may** be a PSBco.

 

If you think your company, or soon to be formed company, may be a PSBco it is important to meet with your tax professional so you can be satisfied that you are paying the correct amount of tax and do not have to fear a CRA audit, and what to do if you are a PSBco.  In many cases being a PSBco can be managed so that it is still financially rewarding for the business owner, but the key is knowing that in advance and then managing your affairs appropriately.  In many other cases it is possible to arrange the relationship between your corporation and its client(s) such that it would most likely not be found to be a PSB.

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