Incorporating a small business in general can provide some tax advantages such as:
- access to the small business deduction
- a potential deferral of taxes if profits are kept in the corporation
- access to the capital gains exemption on sale of qualified small business shares.
But be aware, that sometimes there are negative consequences to incorporating a company.
If you are an individual providing services and incorporate yourself thinking you can take advantage of these, you need to be aware of the Personal Services Business (PSB) rules. These rules were put in place to ensure you are not incorporating yourself just for the advantages available. Some of the rules that apply to PSB’s are as follows:
- A PSB cannot access the small business deduction both federally and provincially and a PSB is denied the general corporate rate reduction (meaning all advantages from a lower tax rate are not available).
- This means that your corporate tax rate could be higher than an individual’s personal tax rate, so you could end up paying MORE tax.
- Expenses for a PSB are restricted to the salary you would otherwise have earned and no deductions are allowed for other expenses such as travel, supplies etc.
Some of the tests CRA may look at to determine whether you should be an employee include the amount of control the company you work for has over the hours you work, whether you have your own tools, who has the risk of profit and loss and whether you have over 5 employees. CRA may also look at how many clients you have (and whether you are working for one company exclusively).
Should any of these make you ask whether you should be incorporated or not or if your employer is asking you to enter into a new work arrangement that requires you to incorporate, you may risk being characterized as a PSB, and should seek advice on your position to avoid a costly reassessment in the future.