You incorporated, signed a contract through a staffing firm, and now you spend your days at a federal department, on their equipment, working with their team. It is one of the most common setups in Ottawa, and it is exactly the arrangement the personal services business rules were written for. If the CRA decides your corporation is a personal services business, the tax advantage of incorporating does not just shrink; it can turn into a higher tax bill than if you had stayed an employee.
This guide explains what a personal services business is, how it is taxed, why Ottawa IT and government consultants are most exposed, how the CRA decides, and what you can do to reduce the risk.
Table of Contents
- What is a personal services business?
- How a personal services business is taxed
- Why Ottawa consultants are most exposed
- How the CRA decides
- How to reduce your personal services business risk
- What happens if the CRA reassesses you
- Why Ottawa consultants choose BBA Tax
- Frequently Asked Questions
Key Takeaways
- A personal services business is a corporation whose owner would reasonably be regarded as the client’s employee if the corporation did not exist.
- Its income loses the small business deduction and the general rate reduction, and pays an extra 5% federal tax, for a combined rate of about 44.5% in Ontario.
- Deductions are limited mainly to the salary and benefits paid to the incorporated employee.
- The CRA looks at the real working relationship, not the contract’s labels: control, tools, financial risk and opportunity for profit.
- Paying yourself a salary and building a genuine business presence both reduce the exposure.
What is a personal services business?
The term comes from subsection 125(7) of the Income Tax Act. A corporation carries on a personal services business when it provides services through an individual, often called the incorporated employee, and two things are true:
- the individual, or someone related to them, is a specified shareholder, which generally means owning 10% or more of any class of the corporation’s shares; and
- the individual would reasonably be regarded as an officer or employee of the client if the corporation did not exist.
There are two exceptions. The corporation is not a personal services business if it employs more than five full-time employees throughout the year, or if the services are provided to a corporation it is associated with. For a one-person consulting company, neither exception usually applies, so the whole question comes down to whether you look like an employee of your client.
How a personal services business is taxed
Most small Canadian-controlled private corporations pay a low rate on active business income thanks to the small business deduction. A personal services business loses that, and more.
| Treatment | Active business (small business) | Personal services business |
|---|---|---|
| Small business deduction | Available on qualifying income | Not available |
| General rate reduction | Available on income above the small business limit | Not available |
| Additional federal tax | None | Extra 5%, for a 33% federal rate |
| Combined rate in Ontario | Low small business rate on qualifying income | About 44.5% |
| Deductible expenses | Reasonable business expenses | Mainly salary and benefits paid to the incorporated employee, plus a few limited items |
The deduction limit is easy to overlook. Under paragraph 18(1)(p) of the Income Tax Act, a personal services business generally cannot deduct the ordinary costs a consulting company runs up, such as a vehicle, office rent or software, unless they fit a narrow exception. Add the higher rate, then the personal tax when the money is paid out as dividends, and the total tax can be higher than if you had simply been an employee. Our overview of what expenses a corporation can write off shows what you would normally be allowed to claim.
Why Ottawa consultants are most exposed
Ottawa has a large community of incorporated consultants, many in IT, working on federal government contracts, often through staffing or brokerage firms. The typical pattern looks a lot like employment: one client for years at a time, work done at the department’s offices, a government laptop, a team schedule, and time sheets.
That does not automatically make you a personal services business. The CRA’s own guidance on IT consultants treats some of these facts as neutral when the nature of the work requires them: working on site and on the client’s secure equipment for security reasons, following a team schedule, filling in time sheets to track project costs, and serving one client at a time. What matters is whether the client controls how you do the work, and whether you carry the risks and chances of a business.
BBA Tax works with government contractors in Ottawa and independent consultants, and this is one of the first things we review when someone incorporates.
How the CRA decides
To decide whether your corporation is a personal services business, the CRA asks whether you would be an employee of the client without the corporation. It uses the same approach it uses for any worker, set out in its page on determining whether a worker’s corporation is carrying on a personal services business. It starts with what the parties intended, then checks whether the actual working relationship matches, looking at:
- Control: does the client direct how and when you do the work, or only what result they need?
- Tools and equipment: who provides and pays for them?
- Subcontracting and helpers: can you send someone else or hire help?
- Financial risk: do you carry costs that are not reimbursed, and could you lose money?
- Investment and management: have you invested in your own business?
- Opportunity for profit: can you earn more by working efficiently, pricing well, or taking on more clients?
The contract’s wording helps show intention, but it does not decide the outcome. Calling yourself a contractor, invoicing monthly and having a corporation are not enough if the day-to-day reality looks like employment. Our guide to employee vs contractor status in Canada covers these factors in more detail.
Not sure where your corporation stands? BBA Tax can review your contracts and working arrangement before the CRA does. Book a free intro call.
How to reduce your personal services business risk
There is no form that makes a corporation immune, but these steps make a real difference, both to the facts and to how you can show them.
- Pay yourself a salary. Salary paid to the incorporated employee is deductible even for a personal services business. Paying out most of the corporation’s income as salary each year leaves little income taxed at the higher rate if the CRA reclassifies it. Our guide to paying yourself as a business owner explains the trade-offs.
- Work for more than one client over time. A history of different clients and contracts is strong evidence of a business.
- Build a business presence. Your own equipment where the client allows it, professional liability insurance, a website, marketing, and a business bank account all show you are in business on your own account.
- Negotiate contract terms that reflect a business. Deliverable-based work, the right to substitute or subcontract where the client permits, and no employee-style benefits help, as long as they match what actually happens.
- Keep evidence. Proposals, pricing decisions, unreimbursed costs and your other clients are what you will rely on if you are ever reviewed.
- Review the structure before incorporating. If the arrangement is essentially employment, incorporating may not be worth it. Our comparison of sole proprietorship and incorporation is a good starting point.
What happens if the CRA reassesses you
If the CRA concludes your corporation is a personal services business, it reassesses the corporation’s past returns: the small business deduction is removed, the higher rate applies, disallowed expenses are added back, and interest runs from the original due dates. How far back it can go depends on the normal reassessment period, which our post on how far back the CRA can audit you explains.
You have the right to object. A notice of objection generally has to be filed within 90 days of the reassessment, and the facts you gathered about your business presence are what support it. BBA Tax represents clients through CRA audits and objections.
Why Ottawa consultants choose BBA Tax
BBA Tax is an Ottawa accounting firm led by Karim, working with consultants, government contractors and small corporations across Ottawa and the surrounding area. We handle corporate taxes, incorporation and bookkeeping, and we deal with the CRA on your behalf.
For consultants, that means reviewing whether incorporating makes sense, setting up salary and dividends to limit personal services business exposure, and keeping the records that show your corporation is a genuine business.
Incorporated consultant in Ottawa? Find out whether your corporation is at risk and what to change. Book a free intro call with BBA Tax.
Conclusion
The personal services business rules exist to stop employees from incorporating only for the lower corporate tax rate, and they hit hard: no small business deduction, an extra 5% federal tax, and very limited deductions. Ottawa consultants on long government contracts are the most exposed, but working on site and on secure equipment does not decide the question on its own. Pay yourself a salary, build and document a genuine business, make sure your contracts reflect how you actually work, and get advice before you incorporate or sign a long single-client contract.
Frequently Asked Questions
What is a personal services business in simple terms?
It is a corporation whose owner would be treated as the client’s employee if the corporation did not exist. The CRA taxes that income at a much higher rate and limits the expenses the corporation can deduct.
What is the tax rate on personal services business income in Ontario?
About 44.5% combined: a 33% federal rate, which includes the extra 5% tax, plus Ontario’s general corporate rate. Dividends paid out of that income are then taxed again personally.
Does working through a staffing agency protect me?
Not by itself. The CRA looks at the actual working relationship, including who controls your work and whether you carry business risk. An agency in the middle does not change those facts.
Does having more than one client avoid the rules?
It helps, because multiple clients over time are strong evidence of a business, but it is not a guarantee. Each engagement is looked at on its facts.
How can I reduce the tax impact if I am a personal services business?
Paying yourself a salary is the main lever, because salary to the incorporated employee remains deductible. That leaves less income in the corporation to be taxed at the higher rate.
Can I object if the CRA says my corporation is a personal services business?
Yes. You can file a notice of objection, generally within 90 days of the reassessment. Evidence of your business presence, other clients and financial risk is what supports it.
