Principal Issues: General discussion on the taxation of personal services businesses.
Position: See letter below.
Reasons: Income Tax Act.
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Dear Honourable Member [of Quebec National Assembly],
Thank you for your letter about small businesses in the information technology sector in Quebec and the tax legislation applied by the Canada Revenue Agency (CRA). Please excuse the delay in responding to you.
Since the circumstances in which income can be earned vary, the Income Tax Act has specific rules to ensure that different types of income are treated equitably. Rest assured that the CRA understands the tax situation you describe regarding small businesses in the information technology sector. However, it must in all cases apply the provisions of the Act as developed by the Department of Finance Canada.
In December 2009, the House of Commons Standing Committee on Finance held hearings on the taxation of corporations operating personal services businesses. The report of this Committee, tabled in June 2010, recommended that the federal government review the Act to reflect the realities of the modern labour market, to ensure tax fairness for small business owners, especially in the information technology sector, which were referred to as "incorporated employees" of "personal services businesses".
In response to the Committee's report, the Government clarified that the provisions of the Act concerning personal services businesses apply to all sectors to ensure that an individual, who would otherwise be an employee, cannot avoid paying the individual’s fair share of taxes through the interposition of a corporation between itself and a service recipient, who would otherwise be the individual's employer. These provisions are intended to ensure that incorporated employees receive treatment comparable to that of actual employees for income tax purposes.
If these provisions were amended to exclude corporations for information technology professionals, these professionals would receive preferential tax treatment over unincorporated employees with respect to the portion of their compensation which is taxed through the business.
Where a taxpayer, whether an individual or a corporation, carries on a business, the Act generally allows the taxpayer to deduct expenses incurred to earn income from the taxpayer’s business, unless otherwise provided by the Act.
However, this is not the case for a corporation that operates a personal services business. Under the Act, such a corporation will only be entitled to the following deductions:
- the salary, wages or other remuneration paid during the year to an incorporated employee;
- the cost of any benefits granted to the incorporated employee during the year;
- the amount spent by the corporation, including that related to the sale of goods or the negotiation of contracts by the corporation, where the amount would have been deductible by the incorporated employee in computing income from an office or employment;
- the amount the corporation paid in the year for legal expenses incurred by the corporation to recover amounts owing to it for services rendered.
Legislation for personal services businesses has been in place for a number of years. Such a business cannot claim the same deductions that are granted to small businesses, such as those related to transportation, employee training and advertising.
Under the Act, a business is considered to be a personal services business if:
- the incorporated employee (that is, the individual who is performing the services on behalf of the corporation) or any person related to the incorporated employee is a specified shareholder of the corporation;
- the incorporated employee would, if it were not for the existence of the corporation, reasonably be considered an officer or employee of the entity receiving the services
Before concluding that a business is a personal services business as defined by the Act, it must be determined whether the incorporated employee was an employee of the customer to whom the corporation rendered the services.
There are three essential conditions for the existence of such an employment relationship: the nature of the work performed by the worker; the remuneration paid for the work by the employer and the existence of a relationship of subordination, that is, the fact that the employer has a power of direction or control over the worker.
The determination of the existence of an employer-employee relationship can only be made in light of all the relevant circumstances. In this regard, the Tax Services Office in the region where an owner of a small business in the information technology sector resides is generally in a better position to make that determination.
In June 2011, Revenu Québec announced the creation of a committee composed of representatives from Revenu Québec, the Canadian Federation of Independent Business and The Quebec Association of IT Freelancers to analyze the situation respecting the employment status of self-employed persons in the information technology sector.
The Committee assessed the relevance of some of the criteria used to determine whether a worker is an employee or self-employed individual carrying on a business, while taking into account the economic reality of self-employed IT workers and the constraints imposed by their clientele.
Revenu Québec has produced a document entitled Status of a worker – Self-employed workers in the Information Technology Sector, which reported on the work of the Committee [formed in June 2011 and consisting of representatives from Revenu Québec, the Canadian Federation of Independent Business and The Quebec Association of IT Freelancers]. Although the criteria that were reviewed are specific to workers in the information technology sector, that Committee did not create new guidelines. The Committee reviewed the criteria recognized by the courts as to whether a worker is an employee or a self-employed worker. The CRA has reviewed this document, and can confirm that the information it contains is consistent with the information in Guide RC4110, Employee or Self-Employed?, which is available on the CRA Web site at www.arc. gc.ca/E/pub/tg/rc4110.
You requested that there be a procedure for taxpayers to give their consent to the CRA so that clients and agencies can explain the nature of their business relationship.
Where the CRA must determine whether a person is an employee or a self-employed person, it must analyze the overall relationship between the worker and the payor. The CRA will ask them questions about their intentions when they agreed on working conditions in order to establish the facts that will help to understand the working relationship. The CRA will verify whether the facts reflect the intention of the parties. If the worker or the payer does not agree with the CRA's decision on the determination of employment status, each of the parties has the right to object within 90 days the date of the notice of the decision. You can find further details on this in the RC4110 Guide.
Where a taxpayer disagrees with an assessment or reassessment issued by the CRA, the taxpayer is entitled to a formal and impartial review by filing an objection within 90 days of the sending the notice of assessment or reassessment. In these situations, Appeals Division officers, who did not participate in the decision, review the taxpayer's file. You will find more information on how to file an objection at www.cra.gc.ca/differends.
I note your comment regarding individuals who provide services through a personal services business (the "Incorporated Employees") who are not eligible to participate in the Canada Pension Plan (CPP) or Employment Insurance.
Under the provisions of the Income Tax Act for incorporated employees, they may participate in the CPP or Employment Insurance. An individual who receives a salary is required to participate in the CPP. Provisions for personal services businesses allow an incorporated employee to participate in the CPP where the individual receives a salary from the personal services business.
The government recognizes that some incorporated employees cannot participate in EI because they own more than 40% of the corporation's voting shares. However, the Fairness for the Self-Employed Act expanded the scope of the Employment Insurance special employment insurance benefits provisions, on the basis of voluntary participation, for self-employed persons and employees who work for a corporation and whose employment was excluded from insurable employment because they held more than 40% of the corporation’s shares. Special employment insurance benefits include maternity benefits, parental benefits, sickness benefits and compassionate care benefits.
I hope this information answers your questions.
Best regards,
Gail Shea, P.C., M.P.
François Bordeleau 613-957-8972