What Is a Personal Services Business (PSB)?

A Personal Services Business (PSB) is a classification under the Canadian Income Tax Act that the Canada Revenue Agency (CRA) applies to incorporated contractors who are essentially employees of their clients — even though they operate through their own corporation. Being classified as a PSB is one of the most severe tax penalties in the Canadian tax system, dramatically increasing the corporation’s tax rate and eliminating most business deductions.

If you are an IT consultant, software developer, engineer, accountant, or any other professional working through your own corporation and providing services primarily to one client, you need to understand PSB rules — the financial consequences of getting this wrong are severe and retroactive.

Pathak Professional Corporation in Mississauga helps IT contractors and incorporated professionals structure their businesses to avoid PSB classification. Call 437-872-7399 for a proactive consultation.

The Personal Services Business Test: Are You a PSB?

Your corporation is classified as a PSB if both of the following apply:

1. The incorporated employee test: If you (or a related person) were not incorporated and instead provided the same services directly to the client, you would be considered an employee of that client (not an independent contractor)
2. The small business test: Your corporation employs fewer than six full-time employees throughout the year

The first test is the critical one — and it uses the same factors that distinguish employees from independent contractors in Canada:

PSB Tax Rate: Why It’s So Devastating

The tax consequences of PSB classification are severe:

Real example: An IT consultant earns $300,000 through their corporation:

• As a CCPC: Pay $300,000 salary (deductible) or leave in corp at 12.2% corporate tax = about $36,600 in corporate tax
• As a PSB: Cannot deduct expenses. Corporate tax on $300,000 at ~44.5% = $133,500 — plus effectively the same personal tax when paid out
• Difference: $96,900 more in tax per year

The 5 Most Dangerous PSB Situations for IT Contractors

1. Single-client IT contractor: Working through a staffing agency placing you at one tech company for 12+ months with all tools provided by the client
2. “Body shopping” through agencies: Agency places you at client sites, client controls your schedule, you attend client’s stand-ups and report to their managers
3. Incorporated employee arrangements: Your former employer convinced you to incorporate and rehire you as a contractor to avoid CPP/EI obligations — this is one of the CRA’s highest audit priorities
4. Long-term IT staff augmentation: You have worked at one company for 3+ years, use their laptop, attend their town halls, and your role appears on their org chart
5. Exclusive service agreements: Your contract prevents you from working for any competitor or other client — exclusivity is a strong PSB indicator

How to Protect Your Corporation from PSB Classification

Structural changes that reduce PSB risk (ideally implemented BEFORE working with new clients):

• Use your own tools: Purchase your own laptop, software licenses, and work equipment — never use client-provided computers
• Maintain multiple clients: Even smaller secondary engagements demonstrate you are running a business, not acting as an embedded employee
• Hire employees or subcontractors: Six or more full-time employees definitively removes you from PSB classification — even one or two reduce risk significantly
• Include substitution clauses in contracts: Your contract should allow you to send a qualified substitute to complete the work — this demonstrates independence
• Remove exclusivity clauses: Never agree to exclusive arrangements that prevent working for other clients
• Avoid the client’s internal culture: Do not use client email, attend internal-only meetings, or appear on organizational charts
• Charge GST/HST properly: Ensure all invoices to clients include HST — this is a standard indicator of contractor status
• Carry your own liability insurance: E&O insurance demonstrates you are accepting business risk as a contractor

PSB and CRA Audits: What to Expect

The CRA has aggressively pursued PSB reclassifications in the technology sector. Common audit triggers include:

• T4 income near zero combined with very high corporate income — suggesting incorporation purely to avoid personal tax
• A single T5 or T4A issued to one corporation for 12+ months
• No employees on T4 payroll for the corporation
• Former employer–employee relationship that converted to corporation-to-company contract

If the CRA reassesses your corporation as a PSB, they will:

1. Deny all business expense deductions (retroactively, potentially 3 years)
2. Apply the higher PSB corporate tax rate on all income
3. Assess penalties for failure to remit CPP/EI if the shareholder was providing services as a deemed employee
4. Charge compound interest on all retroactive amounts

Frequently Asked Questions: Personal Services Business Canada

How does the CRA determine if my corporation is a personal services business?

The CRA uses the same worker-classification tests that distinguish employees from independent contractors, applied to your corporation. They look at factors including: who controls how the work is done (you vs. the client), who provides the tools and equipment, whether you can profit beyond just billing your time or risk a loss, whether you can subcontract the work, and whether you work for multiple clients. The CRA has published guides including IC87-2R and the Worker Classification Questionnaire (RC4110) to help businesses assess their status — but the ultimate determination is fact-specific to each engagement.

What is the additional PSB tax in Canada?

Personal Services Businesses face a 5% additional federal tax (under ITA Section 123.5) on top of the regular 28% federal corporate rate, bringing the combined federal rate to 33%. When combined with Ontario’s 11.5% provincial corporate rate for general corporations, a PSB in Ontario faces a combined corporate tax rate of approximately 44.5% — compared to 12.2% for qualifying CCPCs. The PSB is also denied the Small Business Deduction, the General Rate Reduction, and virtually all business expense deductions except salary to the incorporated employee, employer-paid benefits, and legal fees to collect income from clients.

If I’m classified as a PSB, what expenses can I still deduct?

If classified as a PSB, your corporation can only deduct: (1) salary and wages paid to the incorporated employee (the person providing the services), (2) employer portions of CPP and EI on that salary, (3) employer-paid benefits for the incorporated employee, and (4) legal expenses incurred to collect amounts owed for the services. All other typical business expenses — home office, vehicle, equipment, professional development, meals, travel — are completely non-deductible. This is why PSB classification creates such a dramatic increase in effective tax rates.

Can I convert my corporation from a PSB to a regular CCPC?

Yes — PSB status is determined each tax year based on the current facts. If you restructure your business arrangements (adding employees, taking on multiple clients, using your own tools, removing exclusivity from contracts), your corporation can qualify as a regular CCPC in subsequent years. However, any prior years in which you operated as a PSB remain subject to PSB tax treatment — restructuring is prospective, not retroactive. If you have been operating as a PSB without knowing it, contact a Mississauga CPA immediately to assess your exposure and implement a remediation plan. Call Pathak Professional Corporation at 437-872-7399.