Are you self-employed, incorporated, or working as a contractor through your own corporation? If most or all of your work is for one client, it is important to understand the difference between being self-employed and operating a personal services business.
Operating as an independent contractor is common in Canada. Many professionals work as freelancers, sole proprietors, or incorporated contractors because they want flexibility, control, and the ability to build their own business. However, if you provide services through a corporation and the working relationship looks more like employment than a true business-to-business arrangement, your corporation may be considered a personal services business, or PSB.
That classification can have significant tax consequences. A corporation that earns PSB income is generally not eligible for the small business deduction or the general corporate tax reduction. It is also limited in the expenses it can deduct and may be subject to a much higher corporate tax rate.
What Is a Personal Services Business?
A personal services business is a corporation that provides services to another business through an individual who would reasonably be considered an employee of the payer if the corporation did not exist. CRA often refers to that individual as an incorporated employee.
In general, your corporation may be considered to be carrying on a PSB if all of the following apply:
- You, or someone related to you, is a specified shareholder of the corporation.
- Your corporation provides services to another business, such as a hiring company, client, or other entity.
- You would reasonably be considered an employee of the business receiving the services if your corporation did not exist.
- Your corporation employs five or fewer full-time employees throughout the year.
- The payments your corporation receives are not from an associated corporation.
This is important because a PSB is a corporate tax issue. A sole proprietor may be reviewed by the CRA to determine whether they are truly self-employed or should be treated as an employee, but a sole proprietor is not a PSB because a PSB involves services provided through a corporation.
Personal Services Business vs. Self-Employed Contractor
A personal services business is not the same thing as being self-employed.
A self-employed person may operate as a sole proprietor, partner, or incorporated business owner. A self-employed person usually has more control over how, when, and where the work is done. They may have multiple clients, provide their own tools or equipment, take financial risk, invoice for their work, and have an opportunity for profit.
The CRA looks at the overall working relationship when determining whether a worker is an employee or self-employed. Relevant factors can include control over the work, ownership of tools, the ability to subcontract or hire assistants, financial risk, responsibility for investment and management, and the opportunity for profit.
For incorporated contractors, similar factors can be relevant when determining whether the corporation is carrying on a PSB. The contract matters, but the actual working relationship matters too. If the client controls how, when, and where the work is done, the worker cannot take on other clients, the worker uses the client’s tools or systems, and the worker functions much like an employee, the corporation may have a higher PSB risk.
Why the PSB Classification Matters
The tax consequences of being classified as a personal services business can be significant.
A corporation earning PSB income is generally not eligible for the small business deduction. For Canadian-controlled private corporations that qualify, the federal small business tax rate is 9% on eligible active business income within the business limit. In Ontario, the lower provincial small business rate is 3.2%.
A corporation carrying on a PSB is also generally not eligible for the general corporate tax reduction on its PSB income. PSB income is subject to the full federal and provincial or territorial corporate tax rates, plus an additional 5% federal tax on PSB income.
In Ontario, this can result in a combined corporate tax rate of 44.5% on PSB income: 28% federal tax after the federal abatement, 11.5% Ontario corporate tax, and the additional 5% PSB tax.
What Expenses Can a PSB Deduct?
A PSB cannot deduct the same range of expenses as a regular active business. Deductions are restricted to specific categories.
A corporation carrying on a PSB may generally deduct:
- salary, wages, or other remuneration paid to the incorporated employee;
- the cost of benefits or allowances provided to the incorporated employee;
- certain expenses related to selling property or negotiating contracts; and
- legal expenses paid by the corporation to collect amounts owed for services rendered.
Many expenses that a regular corporation might claim may not be deductible against PSB income. This can create a much higher tax bill if a corporation has been incorrectly filing as a regular small business.
Filing, Payroll, and GST/HST Obligations for a PSB
A personal services business is still a corporation, which means it generally has to file a T2 Corporation Income Tax Return.
If the corporation pays salary or wages to the incorporated employee, its payroll obligations are generally the same as those that apply to regular employers and payers. This may include opening a payroll account, making required payroll remittances, and filing information returns.
A PSB may also have GST/HST obligations. Generally, a corporation must open a GST/HST account, collect, file, and remit GST/HST if it provides taxable goods or services and earns more than $30,000 over the previous four, or fewer, consecutive calendar quarters, unless a specific exception applies.
The CRA Personal Services Business Pilot
The CRA launched its Personal Services Business Pilot in 2022 to better understand PSB arrangements and help corporations and hiring businesses understand their tax obligations.
Phase 1 ran from June to December 2022 and focused on companies that hire PSBs. CRA contacted more than 2,100 Canadian corporations and invited them to participate in an educational outreach activity. CRA’s findings showed that many potential PSBs had incorrectly claimed the small business deduction.
Phase 2 ran from October 2023 to June 2024 and focused on identifying potential PSBs. CRA contacted approximately 2,100 randomly selected accounts from a list of potential PSBs. Of the corporations that participated in the voluntary review, CRA determined that 291, or 32%, were operating as PSBs. CRA also found that 245 confirmed PSBs, or 84%, had claimed the small business deduction even though they were not eligible and had not included the additional 5% PSB tax.
As of CRA’s April 2026 update, the agency states that the findings from both phases show a general misunderstanding about how to properly file a T2 Corporation Income Tax Return as a PSB. CRA also says PSBs, hiring companies, accountants, and tax preparers would benefit from additional education about PSB filing requirements and allowable deductions.
How to Reduce PSB Risk
There is no single action that guarantees a corporation will avoid PSB classification. CRA looks at the actual facts of the working relationship, not just the wording of the contract.
However, businesses may reduce PSB risk by making sure the working relationship reflects a genuine business-to-business arrangement. This may include reviewing whether your corporation:
- has more than one client or the ability to pursue multiple clients;
- controls how, when, and where the work is completed;
- provides its own tools, equipment, software, or workspace where practical;
- has the ability to subcontract or hire assistants;
- has a real opportunity for profit and risk of loss;
- negotiates fees, project scope, and deliverables independently;
- uses contracts that accurately reflect the actual working relationship; and
- keeps proper invoices, records, insurance, and business documentation.
Having multiple clients or a well-written contract may help, but neither is enough on its own. The day-to-day working relationship must support the position that the corporation is operating as an independent business.
What to Do if You May Be a PSB
If you believe your corporation may be operating as a personal services business, it is important to review your tax filings before the CRA contacts you.
You may need to amend prior T2 corporate tax returns, adjust denied expenses, remove an incorrectly claimed small business deduction, include the additional 5% PSB tax, and review payroll and GST/HST obligations.
The CRA states that businesses that want to correct previously filed returns may contact the Voluntary Disclosures Program to determine whether they meet the eligibility requirements.
Because the consequences can be significant, incorporated contractors should speak with a qualified accountant before filing or amending corporate tax returns.
Speak with a Professional
The difference between being self-employed, operating a regular corporation, and being classified as a personal services business can have major tax implications. The answer depends on the facts of the working relationship, the terms of the contract, the number of employees, the type of services provided, and how much control the client has over the worker.
If you are unsure whether your corporation may fall under the personal services business rules, contact us today. Our team can review your structure, contracts, income, expenses, and filing history to help you understand your obligations and reduce the risk of costly tax issues.
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