Why incorporated professionals face serious CRA tax risk
Many Canadian professionals incorporate to reduce taxes, improve flexibility, or meet client requirements. However, if your corporation is structured incorrectly, the Canada Revenue Agency (CRA) may classify it as a Personal Services Corporation (PSC) — triggering severe tax consequences.
This is the “catch-22”:
You incorporate to operate like a business, but CRA may still treat you like an employee.
What Is a Personal Services Corporation?
A Personal Services Corporation is a Canadian tax designation applied when:
- A corporation provides services that would normally be performed by an employee, and
- The individual providing the services would be considered an employee if not for the corporation, and
- The corporation has five or fewer full-time employees
In CRA’s view, the individual becomes an “incorporated employee” rather than an independent business owner
Why CRA Cares About Personal Services Corporations
The CRA closely monitors PSCs because this structure can be used to:
- Avoid payroll taxes
- Avoid CPP and EI contributions
- Access the Small Business Deduction (SBD) improperly
When CRA determines a corporation is a PSC, it removes these advantages entirely.
Tax Consequences of Being Classified as a PSC
If CRA reclassifies your corporation as a Personal Services Corporation:
❌ No Small Business Deduction
❌ No deduction for most business expenses
❌ Higher corporate tax rates apply
❌ Risk of retroactive reassessments and penalties
This can result in tens or hundreds of thousands of dollars in unexpected tax liabilities.
How CRA Determines Employee vs Independent Contractor
CRA does not rely on job titles or contracts alone. Instead, it applies a facts-and-circumstances test, including:
Key CRA Factors:
- Control: Who decides how, when, and where work is done?
- Tools: Who owns the tools, equipment, and software?
- Risk: Who bears financial risk and opportunity for profit?
- Integration: Are you integrated into the client’s operations?
If the client controls your work like an employee, CRA may conclude that the corporation exists only to disguise an employment relationship
Common PSC Example: Incorporated IT Consultant
A frequent PSC scenario involves IT consultants:
- Consultant incorporates to work with a staffing agency
- Works for one client only
- Uses the client’s systems and tools
- Follows the client’s schedule and direction
Despite being “incorporated,” CRA may determine this individual is effectively an employee — resulting in PSC classification.
How to Reduce the Risk of Being a PSC
While no structure guarantees immunity, risk can be reduced by:
✔ Having multiple clients
✔ Setting your own work schedule
✔ Using your own tools and equipment
✔ Bearing financial risk
✔ Having contracts that clearly establish independence
Proper planning before incorporation is critical.
Why Professional Advice Matters
PSC determinations often arise years later during audits, when it is too late to restructure.
At A&R LLP Chartered Professional Accountants, we help clients:
✔ Assess PSC risk
✔ Structure corporations correctly
✔ Respond to CRA audits and reassessments
✔ Defend employee vs contractor classifications
👉 Speak with a tax advisor before CRA does:
https://www.arllp.ca/contact
