Can a Shareholder Be an Independent Contractor to Their Own Company?

If you perform services for a business, it is extremely important to determine whether you are an employee, a self-employed individual (i.e. independent contractor) or a Personal Service Business (if you contract through your own corporation).

I have discussed these controversial income tax issues a couple of times in “I am a Contractor Unless the CRA Says Otherwise” [see the second part of this post updating employee/contractor status] and in “Is Your Corporation a Personal Service Business”.

However, how about the situation where a shareholder of a corporation (whom you would typically consider to be an employee) wishes to treat themselves as an independent contractor and pay themselves a consulting/management fee instead of a salary? As I have been asked this question several times by readers, today, I will discuss a 2012 court case that "sort of" addressed the issue.

Pluri Vox Media Corp

In the 2012 court case, Pluri Vox Media Corp.v The Queen, 2012 FCA 295, the sole shareholder of Pluri Vox took the position that he was an independent contractor (not an employee) to his own company for the following reasons:

1. He was not paid a predetermined salary, but was paid a fee between $3,000 and $8,000 per month based on the commercial activity Pluri Vox undertook.
2. The company asserted that the varying compensation was indicative of the financial risk the shareholder undertook.
3. The shareholder was not directed on how to perform his duties and was able to hire assistants without Pluri Vox’s consent.

Nonetheless, the court ruled the shareholder's status to be that of an employee. As a result of this, the company was liable for payroll source deductions that were not remitted in the past.

This ruling was founded in part on the finding that there was no contract between Pluri Vox and the shareholder and that the shareholder did not invoice Pluri Vox for his services and did not charge GST (despite being registered for GST with the CRA).

However, Justice Webb made an important comment in respect of whether a shareholder can be a contractor to their own company. He stated:

"It would also seem to me that, while this would be unusual, an individual could enter into more than one contract with his or her own company and therefore could provide services in different capacities. It follows that the simple fact that an individual is a director or an officer of a company does not, in and of itself, exclude the possibility that other services may be provided by that individual as an independent contractor. When that occurs, it will be necessary ..... to apportion the amounts paid between the services performed in one capacity and the other."

Thus, the court provided for the possibility a shareholder could be an independent contractor to their own company in certain circumstances.

Justice Webb also commented that where applying the "control" test often used by the courts, “[t]he importance lies in the corporation's legal power to control the employees, not whether the employees feel subject to that control”.

Unfortunately, while the court actually addressed two important concepts, it failed to provide clarity for employee/contractor situations involving a shareholder of a company. Thus, if you own your own corporation and pay yourself as a contractor or through management fees, understand the CRA may come knocking at your door.

Employee vs Contractor

The link above to "I am a Contractor Unless the CRA Says Otherwise" is now almost four and a half years old. I may update this topic in the future, but until then, it should be noted a 2013 Federal Court of Appeal hearing, 1392644 Ontario Inc. (Connor Homes) v. Canada (National Revenue), 2013 FCA 85, has placed a new strong emphasis on the role of “intent” in the determination of whether you are an employee or contractor. In the case the judge applied a two-step approach:

1.The intent of the parties

2. Does the actual reality of the working relationship confirm the intent of the parties?

To reach a definitive conclusion, both steps must be consistent. In examining intent, the courts will examine the contractual relationship or the behavior of the parties, such as were invoices issued and whether or not the worker registered for GST/HST purposes and made various other filings as an independent contractor. The second step will involve a review of the same tests applied in the Weibe Doors and Sagaz Industries cases I note in the "I am a Contractor" post.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Is Your Corporation a Personal Service Business?

One of the first blogs I wrote was "I am a Contractor Unless CRA Says Otherwise" (Note: the link is being temperamental, so if you want to read that blog, either google it or it is listed as a favourite post on the right hand side-bar). In that blog I discussed the various criteria the CRA and the courts use to determine whether a person is an employee or a contractor. I then further discussed the income tax withholding issues that arise when the CRA attempts to re-characterize a contractor as an employee. Finally, I touched upon the concept of a personal service business (“PSB”) and the risk of incorporating if you are a contractor. In today’s post, I will expand on the PSB discussion.

For CFL fans of my vintage, the PSB rules came about because of the despised Ralph Sazio (despised if you were a Toronto Argonaut fan). Mr. Sazio, a member of the CFL Hall of Fame who led the Hamilton Tiger-Cats to three Grey Cup championships, decided he would incorporate a company to provide his services to the Tiger Cats to benefit from the low corporate tax rate. The CRA took Sazio to court, but Mr. Sazio won his case prompting the CRA to implement the PSB rules.

The PSB rules have reared their ugly head recently because of a CRA crackdown on IT consultants as discussed in this Ottawa Business Journal article by Peter Kovessy titled Taxman cracks down on IT consultants.

In addition, on October 31, 2011 the CRA released draft legislation that imposes further punitive rules on PSB's by removing the general rate deduction previously allowed. These new rules will become effective for taxation years beginning after October 31, 2011 and are discussed below.

The PSB rules deal with incorporated employees. Essentially, when a corporation has been interposed between what one would normally consider an employee-employer relationship, the employee becomes an "incorporated employee". As I have discussed in many prior blogs, incorporation is advantageous because it provides the following: access to the small business deduction and the related low income tax rate, a possible deferral of income tax, limited liability, and potential access to the $750,000 capital gains exemption on qualifying small business corporation shares.

In reviewing the PSB rules, you essentially need to ask yourself if you would reasonably be regarded as an employee or officer of the person or partnership to whom you are providing the services, but for the existence of your corporation . If you only have one or two clients and your corporation does not employ more than 5 full-time employees, and you do not meet the criteria I discuss in my contractor blog, you risk being characterized as a PSB.

So what are the income tax consequences of being considered a PSB once the new legislation is passed?

The corporation will be prevented from claiming the small business deduction, both federally and provincially, and as noted above, you will no longer even get the general rate reduction. In Ontario that means the corporation will be subject to income tax at a rate of 39.25% (in 2012). For comparative purposes, the current small business income tax rate is 15.5%. As a consequence, when taking money out of a PSB by way of dividends, the ultimate combined personal and corporate tax rate will approach 58% in Ontario, a very punitive amount which is 12% greater than a high-rate employed taxpayer would pay.

When determining the taxable income from a PSB, the only eligible deduction for the corporation will be any salary and benefits paid to the incorporated employee (yes, that means no other expenses such as travel, office supplies and auto are allowed). If the incorporated employee is a salesperson receiving commissions, expenses paid by the corporation that would have been allowed as a deduction to the individual personally as a commissioned salesperson will be allowed.

If you are concerned that your corporation may be a PSB, a conservative approach would be to pay yourself salary rather than using a dividend remuneration strategy. You may also want to avoid income splitting with family members who are not shareholders, however, your other business deductions are still at risk of being disallowed.

The proposed PSB rules are very punitive. If you may be an “incorporated employee” you should review your situation in detail with your accountant.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.