Personal Services Business (PSB) in Canada: CRA definition, Quebec rules and tax impacts

Did you incorporate to invoice your services? Do you mostly work for a single client, on their schedule and with their tools?

If so, your corporation could be classified by the Canada Revenue Agency (CRA) as a Personal Services Business (PSB). This status matters because it can significantly affect your corporation's income tax and allowable deductions.

Many owners discover the reclassification after the fact. The good news: with a few practical adjustments—and a solid understanding of the rules—you may be able to reduce that risk by aligning facts and documentation with independent-business indicators.

Below, the corporate tax accountants at T2inc.ca explain what a Personal Services Business is, how the CRA and Revenu Québec make a determination, and how to stay compliant while protecting your tax position and planning your corporate tax return.

What is a Personal Services Business (PSB): definition and tax basis

According to the CRA, a Personal Services Business (PSB) is a corporation that provides the services of a shareholder who would reasonably be an employee of the client if the corporation didn't exist. This is the personal services business definition used by the CRA for PSB determination.

In short, it's an "incorporated employee" scenario. This distinction matters because a PSB:

• is not eligible for the Small Business Deduction (SBD); and
• loses access to many of the deductions typically available to active businesses.

Understanding this definition helps you avoid unpleasant surprises and structure your company more strategically.

Quebec rules for Personal Services Businesses (PSB under Quebec's Taxation Act)

In Quebec, the concept of a Personal Services Business (PSB) also applies, but it is governed by provincial law under the Taxation Act, where it is referred to in French as an Entreprise de services personnels (ESP). The principles are aligned with the federal rules set out by the CRA, but Revenu Québec applies its own administrative interpretation and specific tax measures to corporations operating an ESP.

According to Revenu Québec's guidance on special measures for corporations carrying on a PSB, a corporation that functions like an incorporated employee rather than an independent contractor loses several advantages:

• no access to Quebec's Small Business Deduction (DPE);
• no reduced small-business tax rate in Québec; and
• deductions largely limited to salary and benefits paid to the shareholder.

In summary, this rule aims to prevent a company from incorporating solely to reduce its tax burden, without assuming the risks and responsibilities of a genuine business activity.

How the CRA makes a personal services business determination

As per CRA guidance, these are the personal services business rules applied on a case-by-case basis. The CRA assesses five factual elements: the payer's control, ownership of tools, financial risk, integration into the payer's business, and the facts-over-contract principle.

The goal is to establish whether the person performing the work is truly an independent contractor or, in substance, an employee operating through a corporation. The actual working relationship—not the legal form—prevails.

Here are the main factors the CRA considers.

1. Control: who decides what, when and how?

Often the most decisive factor. The CRA looks at how much control the payer exerts over the performance of the work:

• Who decides what tasks are done and how?
• Who sets the schedule and work location?
• Can the contractor delegate or hire help?
• Must the contractor follow internal processes (approvals, supervision, QA)?
• Do they receive directives or training similar to employees?

Independent contractors typically choose how and when they work. The more the payer dictates methods and hours, the higher the risk of a PSB determination.

2. Tools and resources: who provides them?

The CRA also checks who owns and uses the tools. If the client supplies everything (computer, software, vehicle, office, tools), this can point to an employment-type relationship.

A genuine contractor owns or leases equipment, often claiming capital cost allowance (CCA/DPA), covers their own costs, and chooses their resources.

T2inc tip: keep invoices for tools, software and business insurance as evidence of independence.

3. Financial risk: can you earn a profit or incur a real loss?

The CRA looks for true business risk. An independent business can make a profit—but can also lose money if expenses outpace revenue.

They'll consider whether you:

• invest in your business (gear, marketing, insurance);
• carry operating costs even without revenue;
• can negotiate rates or refuse work;
• are paid by the project/task (with no guaranteed income).

Fixed pay with no risk often indicates an employment-type relationship and raises PSB risk.

4. Integration: are you part of the client's internal structure?

This assesses how far the worker is integrated into the client's business. Is the corporation an external subcontractor—or, in practice, a full team member?

Signals of strong integration include:

• attendance at internal meetings;
• use of the client's email domain or IT systems;
• a role similar to regular employees.

Combined with other factors, strong integration can support a PSB conclusion.

5. Facts over contract: does the contract reflect reality?

Written contracts matter—but facts prevail. Even if a contract says "independent contractor," day-to-day operations may say otherwise.

The CRA looks at:

• mandate duration and regularity;
• financial dependence on the client;
• supervision and reporting practices.

Ensure your agreements match reality: flexible hours, own equipment, independent pricing, etc.

Personal services business tax: consequences of a PSB reclassification

A corporation reclassified as a PSB loses the SBD, is taxed at the general combined federal-provincial rate (often 44%+), and faces severely restricted deductions. The result is usually a much higher tax burden.

Loss of Small Business Deduction (SBD)

This is the big one. A PSB is not eligible for the small-business rate on active business income. Without the SBD, income is taxed at the general corporate rate, which is much higher.

Personal services business tax rate (indicative)

On reclassification, your business will be taxed at the combined federal-provincial general rate, which varies by province.

A PSB pays the federal 33% rate (which includes a 5% additional PSB tax) plus the applicable provincial general rate. In 2025, that works out to roughly 44.5% in Quebec and Ontario, and up to about 48% in some provinces such as Prince Edward Island. (Always check current rates.) This reflects the combined corporate tax rate (federal + provincial general corporate rate) applied in a given tax year.

Allowable deductions are very limited

PSBs cannot claim most operating expenses. Typically only the following remain deductible:

• salaries and benefits paid to the shareholder-employee;
• certain costs directly tied to providing the services;
• required statutory contributions (e.g., CPP/QPP, EI, etc.).

By contrast, items like travel, telecom, advertising or home-office expenses are generally not deductible for a PSB. PSB income is subject to narrow expense deductions under the Income Tax Act, and incorrectly claiming the Small Business Deduction can trigger reassessments.

Less flexibility for tax planning

A PSB loses several tax planning tools: income splitting, retaining profits for deferral, and some loss carryovers.

In short, the incorporated structure no longer provides the usual small business tax advantages.

Higher risk of interest and penalties

On audit, the CRA may apply PSB reclassification retroactively for multiple years—reassessing tax plus interest and penalties. The total can add up quickly for income earned in prior years.

Quick comparison: SBD-eligible corp vs PSB

Rates vary by province and year. Always verify provincial corporate tax updates for your fiscal year.

If you're unsure about your status, speak with a CPA or tax specialist before filing your next corporate income tax filing. A preventive check can help you comply with your tax obligations and decide whether you've been considered a personal services business.

PSB and compliance: your obligations

A corporation reclassified as a PSB must still meet the usual corporate tax obligations, with a few specifics.

Corporation

• File a T2 corporation income tax return (and CO-17 in Quebec, if applicable) every year;
• set up payroll and run payroll source deductions (CPP/QPP, EI) for any salary paid;
• register for GST/HST if required once revenues exceed $30,000.

Payer (client)

• Issue a T4A where required for fees paid to the corporation;
• keep contracts and evidence of the business relationship in case of audit.

How to avoid a personal services business determination

A few practical steps often help demonstrate that your corporation runs a genuine, independent business. To show you are carrying on business as an independent contractor rather than an employee, consider the following:

1. Diversify clients and revenue sources

Working full-time for a single client looks like employment. Expanding your client base supports a finding of carrying on business independently.

2. Use your own tools and equipment

Owning or leasing your gear (computers, software, insurance, vehicles) reinforces independent contractor status. Avoid relying exclusively on the client's assets.

3. Keep control over how the work gets done

True contractors decide how/when/where to deliver. Draft agreements for deliverables/results, not for work performed under direct supervision.

4. Use clear, reality-based contracts

Spell out your rights, responsibilities, organizational freedom and ability to delegate. In any review, the paper record matters—but it must match reality.

5. Pay yourself bona fide salary and document operations

Because PSBs are limited in what they can deduct, wages paid to the shareholder are key. Run proper payroll with source deductions. Keep solid records: pay stubs, invoices, contracts, and books.

Personal services business examples

In practice, it's not always obvious whether you're truly an independent entrepreneur or effectively an incorporated employee. The line can be thin.

The CRA PSB pilot described on Canada.ca targets higher-risk sectors (transportation, construction, professional services) and helps taxpayers better understand their tax obligations.

Here are three common field scenarios. If any of them sounds familiar, it's wise to consult a CPA or tax specialist before the busy filing season.

1. IT consultant: exclusive mandate, supervision and fixed hours

An incorporated IT consultant works full-time for one company, follows employee hours and uses the client's systems.

➡️ Outcome: the CRA views them as an incorporated employee. The corporation is reclassified as a PSB, loses the SBD and faces a higher tax rate.

2. Delivery driver: full integration and no financial risk

An incorporated driver uses the payer's truck and uniform and follows preset routes and schedules, with no operating costs or risk.

➡️ Outcome: frequent PSB reclassification due to employee-like integration and lack of business risk.

3. Construction subcontractor: client-provided equipment and single-client dependence

An incorporated subcontractor works only for a major developer, uses the developer's yard and equipment, and follows foremen's directives.

➡️ Outcome: high PSB risk given limited autonomy and economic dependence on one client.

Speak with a professional about your PSB status

A Personal Services Business determination can reshape your corporation's tax profile: overall tax rate, SBD eligibility and allowable deductions.

Spotting warning signs early lets you act before it's too late. Sound structuring, clear contracts and independent operations make all the difference to the CRA and Revenu Québec.

If unsure about your status in Canada—including Ontario or Quebec—speak with a tax lawyer or a tax specialist before incorporating or renewing agreements. A professional review can confirm whether you meet the criteria of an independent business and help you optimize your tax position compliantly.