Employees want to be paid via a corporation? You'll both need to consider these factors first

Key professionals in the dealership sector are increasingly requesting to be paid as independent contractors via their own company rather than as dealership employees. The idea is this will allow them a tax deferral where they can benefit from lower small business tax rates and pay less personal tax.

However, this type of structure carries a risk of the individual becoming an incorporated employee and their company being considered a personal services business (PSB). A PSB is not eligible for the preferable small business tax rate and instead faces the highest federal corporate tax rate of 33 percent, plus the applicable provincial tax rate. In most cases, these will be higher than what the employee would have paid if they earned that income personally.

In addition to high tax rates, PSBs also limit the types of expenses individuals can deduct — typically confined to those an employee could deduct on their personal tax returns (i.e. meals and travel expenses) and wages paid to the incorporated employee.

To be or not to be a PSB

Corporations that employ more than five full-time employees would not be considered a PSB. In any other situation, the shareholder would need to argue the answers to the following four tests indicate their role would be one of independent contractor and not an employee.

1. How much control does the company / operator have over the shareholder’s work? An employee would have little control, whereas an independent contractor would have more.
2. Does the company have an ability to increase its income? Or, is there a risk the company would have financial losses? A salaried or hourly employee would not have risk of loss or chance of profit. An independent contractor risks financial losses, but can also increase their income through efficiencies.
3. Does the company provide the tools to complete the contracts? Normally, an employer provides employees with the tools to do their job while independent contractors provide their own tools.
4. Is the company / operator integrated into the payer corporation? An employee is integrated into the operations of their employer while an independent contractor is not.

Employer advantages

It is usually preferable for employers to pay employees as subcontractors. There are no obvious disadvantages, and the employer could capitalize on the following advantages:

Simpler and more cost-effective payroll — The employer no longer has to make payroll remittances for that employee and would save the employer portions of EI and / or CPP.

Fewer benefits costs — The employer would not have to pay for subcontractors to be a part of the company pension or health benefits plans.

Tax efficiencies — Canada Revenue Agency (CRA) seems to have concluded that provided there is a contractual arrangement between the employer and the corporation owned by the employee, there is no risk the CRA could deny subcontractor expenses an employer incurs, nor assess penalties for not remitting payroll withholdings.

Employee risks

Despite the potential upside of being paid through a company rather than as an employee, there are some concerns individuals will need to grapple with. Namely, even if the employee believes they are an independent contractor based on the four tests, a CRA audit could determine otherwise.

Below is a list of the possible pros and cons an employee should consider in deciding whether to incorporate:

Pros:

Tax efficiencies — They would be able to access the small business tax rate, provided they can substantiate the company is not a PSB and file as a regular small business corporation.

Financial discretion — They would receive more income up front, as their company would receive their gross pay and have no payroll remittances or tax withholdings.

Cons:

Tax costs and penalties — If the CRA were to reassess their filings and determine they are a PSB, the individual would face additional taxes (with interest) and potentially gross negligence penalties for not self-declaring as a PSB.

High tax rates for PSB — If they do file as a PSB, they will need to either: (1) pay high corporate tax, or (2) pay themselves a wage to bring taxable income to $0. In either situation, they are going to pay either the same or more tax than they would have as an employee. Their company would have to pay the employer portion of CPP on any wages paid.

Corporate overhead — They would face the additional costs of incorporating and maintaining a company which they would not incur as an employee.

No benefits — They would not benefit from other perks of being an employee such as health benefits, company pension plan, or vacation pay. Moreover, they would no longer be protected as an employee under provincial employment standards.

Navigating the burden of proof

If an individual chooses to incorporate after a period of employment with the same employer, it’s exceedingly likely a CRA reassessment will determine the new company is a PSB. It would require a notable change in the nature of the individual’s duties and relationship for CRA to acknowledge this new arrangement as one of independent contractor rather than an employee relationship.

There are significant risks and punitive tax rates associated with being assessed as a PSB, so it’s important to consult with a tax advisor before moving ahead with an incorporation. 

To learn more, contact Whitney Procee CPA, CA, Senior Manager, at 403.317.2775 or [email protected]

The above information is a general overview of the subject matter, is provided solely for informational purposes, and may not be applicable to a specific case, set of circumstances, or facts. This material is based on laws and practices that are subject to change and may not represent the views of MNP LLP. This information is current as of the date of publication (2020) and should not be regarded as a substitute for professional advice. Although the content has been carefully prepared, MNP LLP accepts no responsibility or liability for any loss or damage caused by your reliance on information contained in this document. © MNP LLP 2020. All Rights Reserved.