In Canada, for the past few years, the CRA (the Canadian version of the IRS), has been cracking down on IT contractors and reassessing their status to something called a "incorporated employee" AKA the dreaded Personal Service Business .
How does this effect the Canadian developer community? Many IT contractors are required to be incorporated in order to do business with larger enterprise organizations. In addition, being a IT contractor has numerous tax benefits such as:
- Claiming businesses expenses
- Claiming the Small Business Deduction for tax purposes
- Varying methods of payment: Salary vs Dividends
If you are labelled as a Personal Service Business(PSB), then you can no longer claim most business expenses other then salary. As an additional penalty, your income is taxed at the combined: highest corporate tax rate + personal tax rate
This results in a tax rate even higher then if you were a employee in the highest tax bracket!
You might already personally know at least one person whose been hit by the PSB label. Because of this, I wanted to share some of the ways us contractors can reduce the risk of being labeled as such.
What puts you at risk? If you are a IT contractor doing work in a similar fashion to that of your employee counterparts, the CRA does not care if your contract between you and your client explicitly states your status as a contractor. CRA focuses on behavior and commonly applies a few metrics to determine if you are a PSB or not.
So I wanted to list them and illustrate some ways you can lower your risk of reassessment. As a word of note, I'm not a lawyer or accountant. I am however, a contractor, who had to do my own research. So I wanted to share some of my findings to make others aware of how we are at risk for being labeled a PSB and how it can cost us.
Here are some of the metrics used by the CRA:
1. The level of control exercised by the client over the duties the contractor performs.
Freelancers with multiple clients are OK. But the CRA considers a standard 9-5, Monday thru Friday work schedule, employee like behavior (regardless of contractor status).
2. Do you provide your own equipment? or is it provided by the employer?
Many banks and government organizations provide work computers to their contractors. Receiving company equipment to complete daily tasks is considered employee like behavior.
3. Do you hire your own employees or subcontractors?
The CRA is specifically targeting one-person corporations. Companies with 5 or more employees are not considered PSBs.
4. What is the business's opportunity for profit or loss
In other words, does your business keep inventory or have other expenses such that if you earn no revenue, your business takes a loss. Many IT contractors (especially the ones who are provided equipment), have very few expenses -almost all of the contractor's per hour rate becomes profit. As a result, most IT contractors do not incur significant losses if they earn no revenue. Businesses with little risk of loosing money are at risk for a PSB status.
5. Nature of the payment structure
The CRA wants to know if you invoice your client after a period of time or if the client simply pays you every two weeks (which is very employee like behavior).
Most IT contractors who work on-site must work client business hours. In most cases, we unfortunately cannot change this. That being said, CRA considers the above factors in combination to make their determination. So if you are "employee-like" in one factor, you can attempt to make up for it in another.
Always send a invoice to your clients and be sure your invoice includes the charges levied. Though a monthly invoice on a per hour rate is acceptable, the safest types of payment are ones after a certain project milestone is reached.
Make sure your business spends 'some' money on marketing and has a web-presence. You need to show the CRA that you are seeking additional clients (and operates as a normal business). These expenses also show the CRA that you can incur a loss if you do not earn revenue.
Most contractors only work one client at a time. This is very employee like behavior to the CRA so you need to try and diversify your clientele. If you have lucrative anchor clients you don't want give up, then try to do some side gigs as a freelancer.
Employees switching to a contractor status but not changing jobs is one of the most frequent ways people become contractors. Unfortunately, the CRA also knows this and explicitly looks for this behavior.
Other things you can do to lessen the risk include:
- Minimize the profit of your corporation by expensing most of your company revenue as your salary. However, this may not make financial sense for all contractors.
- Complete the required business paperwork (balance sheet, income statement, etc - which is required by law).
- Keep business bank accounts and cash separate from your personal ones.
- Ensure all business expenses are truly business related and reasonable.
- Avoid at all costs being listed as a employee on client email-lists or staff directories. Avoid company perks given out to employees (like meal vouchers and gym memberships).
Navigating the world of IT contracting has been made considerably difficult the last few years. What was once considered an easy path for guaranteed tax savings has become a landscape where developers must constantly be aware of their outward appearance as a employee. A PSB label is year-to-year, so if you get labeled as a PSB, it's not the end of the world. You can be a PSB one year and be safe the next.
It's frustrating at times that this knowledge is horded by layers and accountants who charge exorbitant fees to discuss this. Hopefully my few tips will help you save some money and stay out of trouble.
Are you a Canadian contractor? Do you know about PSB status? What do you do to avoid that? I'd like to know more tips too!
I'm JayC and I like to write about career development, Java/JS dev, and rant 😑.
I also write articles with a group of friends to help others - follow @CanosieLabs labs for more developer-tips and help articles.
Photo Credit: Uunsplash- Loic Leray