The work environment has undergone significant changes in recent years, including the emergence of remote working. This remote working phenomenon is very common in industries such as technology, communications and computing and has led to the emergence of a new status, the self-employed worker.
There is an increasing number of self-employed IT specialists and this is no coincidence. Indeed, one of the trends increasingly adopted by large companies is the outsourcing of certain work to external consultants. This allows them to have fewer employees and therefore reduce costs for payroll, pension funds, training hours, etc. This makes it easy for an independent IT specialist to find work. However, it is crucial for a consultant to carefully choose his or her legal status.
Incorporated employee status
In the labour market, large contractors and companies hire consultants for specific assignments as a business and not as an employee. However, even if the work of this external consultant is invoiced via a company and he does not receive a salary, the tax authorities may still consider him as an employee.
This can create risks for the employer who will have to pay arrears in employer contributions and other penalties. In order to avoid these potential problems, the large companies or employment agencies require each consultant to incorporate through a joint stock company. Indeed, a joint stock company is entitled to its separate legal personality as a distinct legal entity, and therefore cannot become an employee. As such, with incorporation, the employer avoids the payment of withholding taxes and employer contributions on salaries.
Freelance IT specialists are often poorly informed
Large companies often have more financial resources to consult accountants, tax specialists, lawyers and other experts, which is not necessarily the case for a freelance IT specialist. However, keeping informed about the status you choose is essential to avoid finding yourself in a difficult situation.
Many consultants find themselves in a situation where they are considered to have incorporated a joint-stock company to provide their IT or other consulting services to an organization over a long period of time. You should be aware that this situation can be a risk in terms of the personal service business concept and you are exposed to serious tax consequences.
In order to support freelance IT specialists, you can find associations such as the Quebec Association of IT Freelancers or the CQFF which deal specifically with the tax status of freelance IT professionals.
What are the tax risks of being considered as a personal services business?
For a freelance IT specialist, the status of a personal services business should be avoided, since the tax consequences are serious and could be significant for the future of his business.
Indeed, one of the main consequences is that you would be considered as an employee rather than a company. You will therefore no longer be able to deduct your expenses (office, car, telephone, internet, etc.) in your tax returns. There are some exceptions in the law, such as commission employees, but generally, in addition to the RRSP, an employee is not entitled to any deductions or deductible expenses on his or her personal income tax return.
Therefore, if you have deducted a range of expenses for your business over the past 4 years and you are considered a PSB, you run the risk of having your expenses rejected. This means that your taxable profit will be higher, increasing your taxes, penalties and interest. In addition, you will also be required to refund the credits you claimed on your taxable expenses in your GST and QST tax returns.
Another tax consequence of being considered a PSB, and not the least, is that you would no longer qualify for the low tax rate of Canadian-controlled private corporations on the first $500,000 of taxable income. This means that instead of benefiting from a rate of 19-22%, you would have to pay a rate of over 45%, which represents a considerable debt when you combine the last 4 years, penalties and interest.
Lastly, in 2011, a new law was introduced to penalize employees who offer their services through a company. The consequences for an individual are more severe and can be catastrophic. Income paid to an individual as a dividend by a PSB is now subject to a marginal combined rate and income earned by a PSB is taxed at a significantly higher rate than that applicable to an individual's employment income.
What should a freelance IT specialist considered an incorporated employee do?
If you are ultimately considered an employee offering your services through a company classified as a personal services business, you no longer have many options under the new standards introduced on October 31, 2011.
One solution that could be considered is for the consultant to receive a salary equivalent to his income and turnover in order to reduce his company's taxable income to zero as much as possible.
Consult with tax experts
The concept of an incorporated employee is very complex. If you are in a similar situation, we strongly recommend that you consult with tax experts to determine the tax implications of your status. In this way, you will be informed of the potential risks you are facing and the possible outcomes within your reach.
At T2inc.ca, we support and advise a large number of self-employed IT specialists. We therefore invite you to contact us so that we can review your status as a consultant and process your company's taxes.