July 11, 2013
If you provide your services through a corporation, are you carrying on a personal services business? If so, you will lose the tax deferral advantage that this structure previously offered because a tax rate increase on personal services business income has recently become law.
This change is already generally effective for taxation years ending on October 31, 2012 and later. For example, if you have a December 31 taxation year-end, this tax hike applies to your taxation year that ends on December 31, 2012. You will need to evaluate the impact of this tax rate increase on your personal services business and decide what to do with your existing corporation.
|Background — What is a personal services business?|
Your corporation may be considered a personal services business if you provide services on behalf of your corporation to another company and you would reasonably be considered an employee or officer of the company to which you provide services but for the existence of your corporation. If your corporation employs more than five full-time employees or it provides services to an associated corporation, it will generally not be considered a personal services business.
A personal services business is not eligible for the small business deduction and the expenses it can deduct for tax purposes are severely restricted compared to other corporations — usually only salary and wages paid to an incorporated employee are deductible.
These rules were created to discourage employees from ending their employment agreements and instead entering into contracts with their previous employers through their own corporations to get tax advantages.
Tax advantages drastically reduced
Previously, carrying on a personal services business meant the loss of certain deductions and a higher tax rate but there was still a tax deferral advantage to having a personal services business compared to earning the income personally. That deferral has been severely curtailed or nearly eliminated (depending on your province) by the tax rate increase for personal services businesses that recently became law.
Not only has the deferral been significantly reduced, but you will now generally pay much higher total tax when income from a personal services business is withdrawn personally. For details, see TaxNewsFlash-Canada 2013-07, “Personal Services Business Tax Hike Becoming Law — Time for a New Plan”.
You will first need to assess whether your corporation is carrying on a personal services business. If it is, you’ll need to determine the effects of the tax rate increase on your personal services business corporation and decide what steps you should take to mitigate its impact on the corporation’s income and yours as well. For example, you may want to “bonus out” all corporate income as salary or wind up or restructure the corporation. Depending on your province, you may still get a modest tax deferral using a personal services business corporation, so you may want to evaluate whether using the corporation still makes sense, taking all your specific circumstances into account.
If the investments in your corporation have built up significant value, you may want to keep the corporation in existence so you can continue to defer tax on the existing retained earnings until you withdraw them from the corporation in the future.
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We can help
Your KPMG Enterprise adviser can help you evaluate whether you have a personal services business and if so, how the tax rate increase will affect you. We can also help you determine the most tax-effective course of action for you. For details, please contact your KPMG Enterprise adviser.
Information is current to July 10, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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