Governments have consistently lowered taxes over the last several years for business in general but especially for small business.
It was intended to provide a stimulus for business and employment growth in this important sector of the economy.
However, to a certain degree, the Small Business Deduction (SBD) also worked to stimulate a large increase in the number of small Canadian corporations that file their taxes under SBD rates.
About 30 years ago, the government started clamping down on what it called Personal Service Businesses (PSBs) masquerading as small Canadian corporations.
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Generally speaking, the Canada Revenue Agency considers a person operating a business to be a PSB corporation if that person provides services to a client corporation that would normally be provided in the same manner if the person was an employee of the client corporation. The term “incorporated employee” is frequently used to describe this situation.
What concerned the government was the loss of higher–taxed, salaried employees to lower taxed corporations. The government appears to be rethinking the strategy, or at least attempting to stem the loss of tax dollars as a result of this favoured treatment.
The federal finance department recognized this threat to government revenue and acted to remove the SBD and the ability to claim most ordinary expenses from companies that the CRA determines are actually PSBs.
The lowering of the general business tax rates over the last several years and the introduction of new tax rules in 2006 that were more favourable to PSB corporations have essentially taken some of the sting out of measures designed to curb the proliferation of PSBs.
The CRA began putting significant audit pressure on small incorporated businesses to curb the incidence of companies providing personal services but claiming the SBD. It recently performed more than 200 audits and determined that almost half were actually PSBs. Information technology (IT) consulting and contracting businesses have been a particular target.
Here is an example I recently encountered of how this could affect farm businesses.
A husband and a spouse each have an active corporation that is subject to the SBD. The husband’s corporation operates the farm while the wife’s corporation provides IT and computer consulting services. She also works on the farm.
In the past, work conducted by the spouse on farm-related activities was paid as salary and an accompanying T4 slip was provided. This would then be taxed at the marginal tax rate applicable to the spouse, which invariably would be higher than the SBD tax rate.
The question then is, would it not be more favourable tax wise for the spouse’s corporation to invoice the husband’s corporation for work done and thus be taxed under SBD rates?
The problem is that the work done for the husband’s corporation would be considered as work provided by a PSB. Claiming it under SBD rates would almost certainly attract an audit and reassessment by the CRA.
