BC corporations enjoy a 11% corporate tax rate on the first $500,000 of taxable income from active business due to the small business deduction (“SBD”). Most BC incorporated businesses qualify for this tax break. In fact, many businesses structure its business affairs in ways that can take full advantage of this favourable tax treatment.
Consultants Who May Not Be CRA Qualified Incorporated Businesses
However, some “consultants” who may have incorporated their service businesses to take advantage of the low corporate tax rate, not knowing that their corporate income does not qualify for the favorable 11% rate. Currently, CRA is escalating their efforts in this specific area – identifying incorporated employees – also known as “personal services business” in the tax world and apply the appropriate tax rules to these businesses. For an incorporated business that is offside with this rule, the final tax costs could be dire.
CRA: Self-Employed Consultant Qualifications
In order to qualify as a self-employed consultant, one must avoid being regarded as an employee by the CRA. Hence, act like a consultant and not an employee.
Below is a sample list what “real” consultants do to stay in business:
- print business cards
- develop a website with client testimonials
- have more than one client
- join business networking groups
- buy state of the art computer equipment to improve productivity
- set their own hours
- pay for an office premise to meet various clients
- stay off the paying client’s group benefit plans
These are just some of the more obvious criteria that the CRA use to differentiate a consultant from an employee. Failure to establish yourself as a true incorporated consultant has dire tax consequences.
First of all, personal services businesses are only allowed to deduct wages paid to the person performing the services and other employment related expenses (which are very limited). Secondly, the corporate income retained by a corporation is taxed at 50% (BC rate), which is way higher than the favorable 11%.
Take note that the Canadian corporate tax system is based on two corporate tax rates, currently 11% for
corporate profits qualifying for the SBD and 27% for corporate profits not qualifying for the SBD. These
rates in conjunction with the eligible vs non-eligible dividend tax regime are meant to bring integration.
PSB tax rate at 50% creates integration cost, even if the dividends are taxed as eligible dividends at the
What are the tax planning options if you are an incorporated consultant?
Many large corporations with ongoing projects often hire consultants on a full-time basis for a predetermined period and, for various reasons, these organizations often require the consultant to be incorporated. If the service provider does not meet the self-employed test, the best tax planning option is to reduce the annual corporate taxable income to zero by paying the service provider a salary and whatever travel expenses incurred to earn the salary. Then, there is no risk of reassessment if a CRA audit occurs.
The expenses a PSB is entitled to deduct are limited to the following:
- salary paid to the service provider
- employment benefits for the service provider
- expenses that would be allowed if the individual were a commissioned salesperson
- legal expenses incurred by the corporation to collect amounts owing to it
For corporations that used the small business deduction but are subsequently regarded as a personal services business during a CRA audit, the tax costs are high. First of all, expenses deducted outside of the allowed expenses listed above would be disallowed and taxed at the PSB rate of 50%. In addition to the corporate taxes, these draws will be taxed personally to the shareholder. In effect, the taxpayer is paying tax twice on the same funds drawn from the corporation. And of course, there would be interest and possible penalties.
The tax consequences of an employee pretending to be a corporation is costly.