Personal Services Business: When Your Company Is an Employee
Why a one-person corporation that works like an employee loses the small business rate and most deductions, the tests the CRA applies, and the cross-border contractors most exposed.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A personal services business is a corporation through which an individual provides services to a client in circumstances where, without the corporation, that individual would reasonably be regarded as the client's employee. The corporation loses the small business deduction, pays an additional 5 percent federal tax, and may deduct almost nothing except the salary it pays the individual.
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What are the consequences?
| Item | Ordinary small business corporation | Personal services business |
|---|---|---|
| Federal corporate rate on the income | 9 percent small business rate on the first $500,000 of active business income | 33 percent — the 28 percent rate without the 13 percent general rate reduction (section 123.4), plus the additional 5 percent (section 123.5) |
| Deductions | All ordinary business expenses | Salary, wages, and benefits to the incorporated employee, certain selling and contract-negotiation expenses, and legal costs of collecting fees |
| Provincial rate | Small business rate | General rate |
| Combined effect | Low-rate deferral | Often higher tax than if the individual had simply been an employee |
Because the CRA reassesses several years at once, the bill can exceed what the business earned after the individual's salary.
How does the CRA decide?
The question is whether the individual would be an employee of the client under the ordinary tests: who controls the work, who provides the tools, whether there is a chance of profit and risk of loss, and how integrated the worker is into the client's operation. Fixed hours, a single long-term client, the client's equipment and premises, and pay by the hour point toward employment. Multiple clients, own tools, invoicing by deliverable, and the ability to subcontract point away from it.
What are the exceptions?
- The corporation employs in the business more than five full-time employees throughout the year.
- The amount paid for the services is received from a corporation associated with it in the year.
- Separately, the definition applies only where the individual (or a related person) is a specified shareholder — someone owning, directly or indirectly, at least 10 percent of any class of shares of the corporation or a related corporation — so a worker below that threshold is outside it.
Who is most exposed?
Information technology contractors on long engagements, truckers incorporated at a carrier's request, consultants placed through agencies, and — relevant to cross-border work — Canadian residents who incorporate to serve a single U.S. company remotely. The CRA launched a personal services business pilot in 2022 — outreach and voluntary reviews that found likely personal services businesses concentrated in trucking, professional and technical services, and construction, many wrongly claiming the small business deduction — and Budget 2025 proposed funding for a focused compliance program.
What about the U.S. side?
A Canadian corporation serving a U.S. client has its own questions — permanent establishment, Form W-8BEN-E, and whether the individual is in fact a U.S. employee for payroll purposes. The personal services business rules are Canadian; the U.S. client's classification of the worker is separate, and both can go wrong at once.
How do you reduce the risk?
Multiple clients, written contracts that reflect real independence, your own equipment and insurance, the ability to send substitutes, and pricing by project rather than hours. Where the facts are genuinely those of employment, paying the individual a salary equal to the corporation's income limits the damage, since salary is the one deduction allowed.
Frequently asked questions
Does paying myself a salary avoid the problem?
It eliminates most of the corporate tax by deducting the income out, but the corporation still cannot deduct other expenses and still loses the small business rate on anything retained.
Can the CRA reassess my client as well?
The client may face employer payroll obligations if the CRA concludes the individual was its employee.
Is a holding company structure a solution?
No. The test looks through to the individual providing the services.
Does this apply to a sole proprietor?
No. The rules apply only where a corporation is interposed.
Official sources
The CRA explains: “For example, the income earned from carrying on a PSB is not eligible for the general tax reduction or the small business deduction, which allow certain other corporations to reduce their corporate tax rates. PSBs are also subject to an additional 5% tax and are limited in the types of expenses they may deduct from their income.” — Canada Revenue Agency, What is a PSB, https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/corporation-income-tax-return/tax-implications-personal-services-business/what-psb.html
The Income Tax Act provides: “is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless” — Justice Laws Website (Government of Canada), Income Tax Act, section 125, https://laws-lois.justice.gc.ca/eng/acts/i-3.3/section-125.html
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our Canadian Tax Desk reviews contractor arrangements against the personal services business tests before the CRA does. See pricing or book a free fit call.
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