Personal Services Business (PSB)
The PSB classification is the single biggest tax trap for IT contractors and management consultants in Canada. If your corporation is reclassified, you lose the Small Business Deduction and almost every business expense.
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Guidance, not advice. We explain the rules, we don't assess your situation. Always seek financial or tax advice from your accountant, or contact CRA. Read our editorial scope →
1. What is a PSB?
ITA s.125(7): a Personal Services Business is a corporation that provides services where the person performing those services — the "incorporated employee" — would reasonably be regarded as an officer or employee of the client if not for the corporation.
Plain English: if you incorporated mainly to work for one or two clients, and those clients treat you like an employee in everything but name, CRA may classify your corporation as a PSB.
2. The tax penalty
- No Small Business Deduction. You lose the 9% federal SBD rate (and the provincial small-business rate).
- Corporate tax rate jumps to ~33% federal (full rate plus the additional 5% PSB surtax under s.123.5).
- Combined rate: ~38–44% depending on province, versus 11–13% on SBD-eligible income.
- Severely limited deductions — s.18(1)(p): only salary/wages to the incorporated employee and benefits/allowances the employee actually received.
- Cannot deduct: rent, vehicle, travel, subcontractors, supplies, professional fees, phone, internet — the normal business deductions.
3. The $120k three-column comparison
| True employee | Genuine contractor | PSB (worst case) | |
|---|---|---|---|
| Gross income | $120,000 | $120,000 | $120,000 |
| CPP / EI | Employer pays half | Both sides | Both sides via corp |
| Corporate tax | n/a | ~$13,200 (SBD) | ~$33,600 (no SBD) |
| Deductible expenses | Very limited (T2200) | Full T2125 / corporate | Almost none |
| Personal extraction tax | Marginal on salary | Salary / dividend mix | Marginal on salary only |
| Net after all tax | ~$85k–$90k | ~$88k–$93k | ~$72k–$78k |
| Verdict | Predictable | Best outcome | Worst of all worlds |
4. The CRA tests — Wiebe Door factors
From Wiebe Door Services Ltd v MNR [1986] and 671122 Ontario v Sagaz Industries [2001 SCC 59], with the intention overlay from 1392644 Ontario (Connor Homes) v MNR [2013 FCA 85]:
- Control: who directs how, when, and where work is done?
- Tools and equipment: who provides them?
- Chance of profit / risk of loss: can you earn more by working smarter? Can you lose money?
- Integration: are you integrated into the client's business or independent?
- Intention (Connor Homes): did both parties intend a contractor relationship at formation?
5. Industries CRA targets
- IT consulting and software development (#1 target)
- Healthcare professionals — locum nurses and physicians
- Engineering and construction management
- Management consulting
- Oil & gas contractors (especially Alberta)
6. PSB avoidance checklist
- ✓ Multiple clients (not one or two)
- ✓ Own equipment and tools
- ✓ Control your own methods, schedule, location
- ✓ Ability to subcontract the work
- ✓ Bear financial risk — fixed-price contracts, warranty obligations
- ✓ Invoice for deliverables, not hours
- ✓ Public presence — website, business cards, marketing
- ✓ Written contract specifying independent contractor relationship
- ✓ Genuine ability to decline work without consequence
7. If you're at risk
- Request a CRA ruling: Form CPT1 (either party can apply).
- Restructure: add genuine clients, own your tools, move to deliverable-based contracts.
- Consider deincorporating: a one-client contractor may be better as a sole proprietorship — full T2125 deductions, no PSB risk, simpler compliance.
- If CRA reclassifies: file a Notice of Objection (Form T400A) within 90 days of the assessment.
8. The 5-employee exception
A corporation that employs more than five full-time employees throughout the year generally does not qualify as a PSB, even if it works primarily for one client. The bar is genuine full-time staff, not friends-and-family payroll.
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