An individual who provides services may choose to incorporate for commercial or tax advantages. Depending on the circumstances, significant tax efficiencies can be gained by incorporating. These benefits include income tax deferral by earning and reinvesting business income through a corporation, preferential corporate tax treatment such as the small business deduction (SBD) for a Canadian-controlled private corporation (CCPC) earning active business income, the potential to utilize rollover provisions designed to defer the taxation of gains, income splitting (subject to TOSI rules and shareholder benefit restrictions), and other incentives such as the lifetime capital gains exemption (LCGE).1

To prevent individuals who would otherwise be employees from incorporating and taking advantage of these corporate tax advantages, the personal services business (PSB) rules were enacted to limit these tax advantages to where the parties actually behave as they would under an independent contractor/client relationship, rather than merely an employee/employer relationship dressed up as something else.  If the latter is found to apply, the corporation may be found to be carrying on a PSB which will result in the denial of deductions for ordinary business expenses and a punishingly high tax rate on the corporation's income (with no SBD).

For 2021, the corporate tax rate that applies to PSB income is 33% federally2 and 8% provincially if Alberta rates apply, for a combined corporate tax rate of 41%. The PSB tax rate is substantially higher than the combined federal and Alberta general corporate tax rate of 23%3, or the combined small business tax rate of 11%4.

Personal Services Business (PSB)

According to subsection 125(7) of the Income Tax Act (the "Act")5, the PSB will apply in the following circumstances:

  1. An individual renders services on behalf of the corporation (an "incorporated employee");
  2. The incorporated employee or any related person directly or indirectly owns 10% or more of the issued shares of any class of the corporation or of any related corporation (a "specified shareholder"); and
  3. The incorporated employee would be considered an officer or employee of the client but for the existence of the corporation.

If the above circumstances apply, then it will be necessary to determine of any of the two exceptions are applicable:

  1. The corporation employs more than five full-time employees throughout the year [125(7)(c)]; or
  2. The remuneration paid to the corporation was for the services provided to an associated corporation [subsection 125(7)(d)].

The deductions for a PSB are restricted pursuant to paragraph 18(1)(p). The only deductions permitted for a PSB are:

  1. The salary, wages, other remuneration, benefits or allowances paid in the year to the incorporated employee;
  2. The expenses incurred by the corporation for the selling of property or negotiating of contracts if the amount would have been deductible to the incorporated employee per the employment agreement; and
  3. The legal expenses incurred by the corporation for collecting amounts on account of services rendered.

Where the services of two spouses working for the same PSB corporation are "incorporated employees", only their salaries are deductible in computing the income of the PSB.6 If the PSB corporation hires an individual not considered an incorporated employee, then the remuneration cannot be deductible to the corporation (but remains taxable to the individual).  

PSB Caselaw

Most of the litigated cases involving PSBs involve a determination of whether an individual would be considered an officer or employee of the client but for the existence of the corporation. If substance of the parties' arrangement is that of an independent contractor relationship, then the punitive PSB rules will not apply.

The traditional employee-independent contractor analysis first evaluates the intention of the contracting parties (as evidenced by their agreements and actions i.e., presence of contractor agreement, invoices, GST/HST registration etc.) before moving to an evaluation of the broad factors outlined by the Federal Court of Appeal in Wiebe Door  Services Ltd. v. Minister of National Revenue, [1986] 2 C.T.C. 200 (Fed. C.A.) [Wiebe Door] and confirmed by the Supreme Court of Canada in 671122 Ontario Ltd. v. Sagaz Industries,  2001 SCC 59 [Sagaz]. The latter factors include but are not limited to: the degree of control the employer has over the worker's activities (a right to control rather than actual control); the provision of tools or equipment; ability to subcontract work; chance of profit and risk of loss; the degree of responsibility for investment and management; and the integration of the worker in the employer's business. A consideration of these factors in the totality of the relationship is used in determining the central question of whether or not the worker is performing services in business on their own account.7 For further discussion on the traditional employee-independent contractor analysis, please see our previous  blog.

Unlike the traditional employee-independent contractor analysis, when applying this analysis in the context of the PSB rules, subjective intention of the parties is disregarded for artificiality. Since the PSB definition imposes a hypothetical circumstance (disregard the existence of the corporation and examine the parties' actions otherwise), and a corporation cannot be an employee in an employment agreement, an independent contractor relationship would always have been intended by the parties. Therefore, subjective intent is irrelevant.8

Accordingly, the employee-independent contractor analysis in the PSB context is modified as the Courts will move to a review of the open-ended factors (level of control, risk, own equipment, ability to subcontract, opportunity to profit) in assessing the totality of the relationship of the parties in the hypothetical circumstance (non-existence of corporation). Whether an employee or independent contractor relationship applies between the "incorporated employee" and the client still requires an examination of all the facts and circumstances in answering the question of "whether an individual is providing services to another person as an employee, or as a person in business on his or her own account". 9

The Tax Court of Canada in C.J. McCarty Inc. v. R., 2015 TCC 201, allowed a consultant's appeal who was found not to be carrying on a PSB. Ignoring the intention between the parties and turning to the facts and factors, the court found on the totality of the evidence that the factors tipped towards an independent contractor status. Factors that pointed away from an employment relationship included: a lack of control (exclusivity); services of the consultant were not integral to the client's business; provision of tools (no tools were provided by the client), and that there was a significant risk of loss (risk of being sued). Conversely, in G & J Muirhead Holdings Ltd. v. R, 2014 TCC 49, all the working hours were controlled by the client and the services were integral to the client's business. These factors tipped towards a finding of an employment relationship, whereby the PSB status applied.

In Ivan Cassell Ltd. v. R, 2016 TCC 53, the owner of a corporation in the retail oil and gas business was held to be carrying on a PSB. In examining the hypothetical question, the court found that the factors pointed toward services being provided to grow the client's business and not his own. The Tax Court of Canada noted the lack of marketing, written agreements, invoices and that the corporation did not charge or collect HST on the fees paid to it by the client in concluding the owner was not conducting services in a business-like manner.10 Furthermore, the compensation received by the corporation was similar to that paid to a senior employee (fixed monthly amount and bonus structure tied to profitability and not services). Furthermore, the owner was not exposed to risk of loss given the fixed compensation structure.11 Although the owner was not subject to significant control by the client and did not have a dedicated office space at the client's premises, the court found that the level of control was not inconsistent with that of a senior employee. The owner and client still had weekly meetings, and the lack of a dedicated office space was found not to be determinative since makeshift space was available (laptop atop banker's boxes). Furthermore, the owner was provided with use of the client's vehicles (which were also available to the client's employees) in conducting its business. In considering the totality of these factors, the Court found that PSB status applied.

In Arora Trading Ltd. v. The Queen, 2019 TCC 98, the taxpayer's appeal was allowed in part. In this case, a spouse (wife) controlled a CCPC who entered into a services agreement with a company controlled by the other spouse (husband) in the oil and gas sector. In one taxation year, no services were held to be rendered by anyone on behalf of the corporation, so that paragraph (a) of the PSB definition in subsection 127(5) could not be met.12 Accordingly, the PSB did not apply in that taxation year. However, in the second taxation year, the Tax Court of Canada found that "but for" the existence of the corporation, the wife was an employee of the husband's company. Relevant factors considered were: the use of the husband's office, equipment and supplies without charge; all income from the corporation had come from the her husband's company; no invoices were provided; and the same kind of work was done by the corporation as the other full time employees in both taxation years.13 The court also considered the issue of whether an independent contractor could be considered an employee for the purposes of meeting the exception in paragraph (c) of the PSB definition, whereby the PSB definition would not apply if the corporation employed more than five full time employees. In this case, the corporation employed five full-time employees and one independent contract. Visser J. employed a textual analysis and found the wording of paragraph (c) was clear on the issue. The exception applied to only employees and not other service providers.14Therefore, the exemption of more than five full time employees did not apply even though the corporation had five full time employees and one independent contractor. Accordingly, PSB status applied for that taxation year.

Professional Corporations

A professional corporation ("PC") carries on the professional practice of a regulated member of a profession. In most cases, income from a PC is active business income eligible for the SBD.15 However, it is important to note that the same PSB determination applies irrespective of whether a corporation is a PC, and a PC could still be at risk for PSB characterization in some circumstances.

For instance, in Bruce E. Morley Law Corp. v. R., 2002 D.T.C. 1547, the individual was a lawyer who was employed by his law corporation to provide legal services as in-house counsel to a client of the law corporation. The sole issue was whether the lawyer, as an incorporated employee, would reasonably be regarded as an officer and employer of the client but for his law corporation that provided the services.16 The Tax Court of Canada found that the lawyer's goodwill from his legal practice was transferred to the client in coordinating legal services, and that these services were personally performed by him for a client who had a full-time officer position in mind. Moreover, the court noted that for a PSB not to apply, there needed to be "independence in the context of the services to be performed liberating the performer from the confines of a contractual expectation that requires a particular person to be personally present at, on essentially a full-time basis".17 Therefore, even if the lawyer was not found to be an officer, the corporation would still be a PSB, and the SBD and ordinary corporate deductions thereby denied.


Most issues involving PSB status involve answering the hypothetical question of whether the individual is considered an employee or independent contractor of the client, ignoring the existence of the corporation. In such a determination, a written contract indicating an independent contractor relationship will be insufficient. While the entire relationship between the parties will be scrutinized as a whole, and no one factor remains determinative, the caselaw provides some guidance with respect to common pitfalls and tips to avoid PSB status:

a) Ensure the factors espoused in Sagaz  and Wiebe Door point towards an independent contractor status. For instance, examine if the individual is sufficiently exposed to risk of loss. Will the individual have to fix mistakes on their own time? If something goes wrong, is the individual directly exposed to liability? Furthermore, limiting the overlap of functions of employee and contractors, and differentiating the remuneration/benefit structure between the independent contractor and employees of client would further assist in tipping the scale towards independent contractor status. Another factor to consider is whether the client lacks the right to control the individual.  Is the individual under direct control of the client? How often does the individual meet with the client? In Ivan, the Tax Court of Canada found weekly meetings to be consistent with that of a senior employee. Regarding the provision of equipment factor, if the individual is using the client's equipment or tools, the client should charge for the use of same.

b) If meeting the PSB exception for more than five full-time employees, ensure all workers are employees. The Tax Court of Canada in Arora had provided that if one of the six workers is an independent contractor (even if the other five are employees), the independent contractor will not be considered in making the determination. The PSB exception in Arorafailed on this basis. An employee relationship must apply between the alleged PSB corporation and more than five of its full-time employees to meet the exception.

If PSB status is unavoidable and applies to the corporation, then consider paying the entire contract earnings of the corporation to the incorporated employee as salary to allow the tax deduction to the corporation and prevent the income from being taxed at the higher PSB rate (i.e. 41%, if in Alberta). Also, when the PSB corporation pays wages or salaries, the PSB corporation will remain subject to payroll withholdings and CPP contributions (CPP only, no obligation for EI premiums given non-arms length relationship). Failure to remit same can result in personal director's liability against the director(s) of the corporation.


1 Laura Gheorghiu and Malya Amghar, "The Decision To Incorporate," in Taxation of Private Corporations and Shareholders, 5th ed. (Toronto: Canadian Tax Foundation, 2020), 2:1-57.

2 Increased from 28% to 33% in the 2016 Federal Budget, effective for 2016 and later taxation years.

3 2021 general federal corporate income tax rate is 15%, and Alberta corporate tax rate is 8%.

4 For CCPCs claiming the SBD in 2021, the net federal and Alberta tax rate is 9% and 2%, respectively, for the business limit of $500,000. The general corporate tax rate applies to active business income in excess of $500,000.

5 The Income Tax Act, RSC 1985, c.1 (5th Supp.), as amended.

6 CRA document no.: 2011-0411871C6, October 7, 2011, "Employé constitué en société", at the round table on federal taxation of the 2011 Congrès annuel de l'APFF.

671122 Ontario Ltd. v. Sagaz Industries,  2001 SCC 59 at para 47 [Sagaz].

G & J Muirhead Holdings Ltd. v. R., 2014 TCC 49, 2014 D.T.C. 1067 (Eng.) (T.C.C. [Informal Procedure]).

Dynamic Industries Ltd. v. R., 2005 FCA 211 at para 50.

10 Ivan Cassell Ltd. v. R, 2016 TCC 53 at para 45.

11 Ibid.

12 Arora Trading Ltd. v. The Queen, 2019 TCC 98 at para 25 [Arora].

13 Ibid  at para 28.

14 Arora, supra note 13, at para 31.

15 For example, in Robertson v. R., 2009 TCC 183, the taxpayer was an engineer who provided services through his corporation. The Court found that the corporation did not carry on a PSB after examining the facts.

16 Bruce E. Morley Law Corp. v. R., 2002 D.T.C. 1547, at para 6 [Morley].

17 Morley, supra note 19, at para 43.

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