Good afternoon, Mr. Chair and members of the committee.
My name is Lucie Bergevin and I am the Director General of the Audit Professional Services Directorate.
With me today are Mr. Wayne Adams, Director General of the Income Tax Rulings Directorate, and Ms. Susan Betts, Director of Technical Applications.
A personal services business is defined in subsection 125(7) of the Income Tax Act, as a business that provides the services of an "incorporated employee" to an entity, where the "incorporated employee" would otherwise reasonably be regarded as an employee.
From a tax perspective, the critical issue relating to a personal services business is whether an incorporated individual is considered to be an employee of the client or an independent contractor, when providing services to a client.
Let's say an employee who is a resident in Canada resigns from his job with a corporate employer. The individual establishes a new corporation. He has his new corporation enter into a contract to provide his services back to his previous employer. The individual is referred to as an "incorporated employee".
In effect, the "incorporated employee" could be using the new corporation to convert employment income into active business income of the corporation, which would be eligible for the small business deduction. Consequently, the "incorporated employee" would benefit from the lower tax rates offered by the corporation.
Therefore, the key question is this: if it were not for the service corporation, would there be an employment relationship between the individual providing the service and the entity receiving the service?
In fact, the personal services business income tax legislation came into effect in 1981 to prevent employees from incorporating simply in order to gain access to the small business deduction and favourable tax rates.
In practical terms, the goal of this provision is to create a level playing field in that incorporated individuals, who are in reality considered to be employees, are treated the same way for tax purposes as a regular employee.
If an "incorporated employee" falls under the income tax definition of a personal services business, it is subjected to corporate tax at the full corporate rate.
In addition, subsection 18(1) of the Income Tax Act limits the deductions that a personal services business can claim to generally only those deductions that employees can claim. The corporation cannot deduct the variety of expenses that would be available to other types of businesses.
Examples of expenses that are not deductible by a personal services business include bank charges, office supplies, professional fees, repairs and maintenance, capital cost allowance and advertising expenses.
An exception is provided where the corporation employs more than five full-time employees. The business will not be considered to be a personal service business and it will therefore be eligible for the lower tax rate and usual business deductions.
In conclusion, whether a person is an employee or a self-employed contractor is a question of fact, which can only be determined following a complete analysis of the service contract. CRA has a guide RC4110, Employee or Self-Employed, which assists in determining the nature of the contract.
Thank you Mr. Chair, and we will be happy to take questions from members of the committee.