A personal services business (PSB) is a corporation through which an “incorporated employee” provides services that would otherwise be employment. If the Canada Revenue Agency (CRA) classifies your corporation as a PSB, it loses the small business deduction and the general rate reduction, pays an additional 5% federal tax, and may deduct almost nothing beyond the salary paid to you. In Ontario, that adds up to a combined 44.5% corporate rate. Contractors billing a single client through their own corporation are the most exposed — and it’s exactly the profile of a lot of incorporated IT consultants, engineers and project managers across the Markham and Richmond Hill tech corridors.
Table of contents
- What is a personal services business?
- The four conditions: are you a PSB?
- How the CRA decides you’d “reasonably be regarded as an employee”
- What PSB status costs: the 44.5% calculation
- The deductions you lose (this is the expensive part)
- The CRA’s personal services business pilot
- How to fix it before the CRA finds you
- We help incorporated contractors get this right
- Frequently asked questions
What is a personal services business?
A personal services business exists when an individual — the incorporated employee — provides services to another organization through their own corporation, in circumstances where, if the corporation didn’t exist, that individual would reasonably be regarded as an employee of the organization receiving the services. The CRA’s own guidance on what a personal services business is sets out the definition and the test behind it.
What “incorporated employee” means
The term describes the specific person actually performing the work — not the corporation as an abstract entity. If you incorporated so a client could pay “Company Inc.” instead of “you,” but you personally show up, take direction, and do the job the way an employee would, the CRA looks through the corporation to the working relationship underneath it.
Why the CRA cares
The PSB rules exist to stop what would otherwise be employment income from being converted into corporate income taxed at small-business rates, with all the deductions and income-splitting flexibility a real business gets. A corporation that is really just one person doing one job for one payer isn’t a small business in the sense the tax system was built to encourage — it’s an employment relationship wearing a corporate structure, and the Income Tax Act taxes it accordingly.
The four conditions: are you a PSB?
A corporation is carrying on a personal services business when all four of these apply, per the CRA’s page on determining if a worker’s corporation is carrying on a PSB:
| Condition | What it means |
|---|---|
| Specified shareholder | The individual performing the services owns, directly or indirectly, at least 10% of the shares of any class of the corporation (or is related to someone who does). |
| Would otherwise be an employee | If the corporation did not exist, the individual would reasonably be regarded as an officer or employee of the person or partnership receiving the services. |
| Fewer than six full-time employees | The corporation employs fewer than six full-time employees throughout the year. |
| Not services to an associated corporation | The services are not provided to a corporation the payer’s corporation was associated with in the year. |
If all four conditions describe your corporation, the CRA treats it as a personal services business for the year, regardless of how the contract is worded.
The “five full-time employees” escape hatch — and why most contractors can’t use it
A corporation with six or more full-time employees throughout the year is not a PSB, full stop — that’s the one bright-line exit written into the test itself. In practice, this rarely helps a solo incorporated contractor: hiring five additional full-time staff to escape a tax classification is not a realistic move for someone billing a single client, and part-time or contract help doesn’t count toward the six.
How the CRA decides you’d “reasonably be regarded as an employee”
The second condition — the “would otherwise be an employee” test — is where most of the real analysis happens, and the CRA leans on the same common-law factors used to distinguish employees from independent contractors generally.
Control
Does the payer control how, when and where the work gets done, the way an employer controls an employee? Or does the corporation decide its own methods, schedule and priorities, the way a genuine business would?
Tools and equipment
Who supplies the laptop, the software licences, the workstation? An employee typically uses the employer’s tools; an independent business typically supplies and maintains its own.
Subcontracting and hiring assistants
Can the corporation send someone else to do the work, or must the named individual personally perform every task? The ability to substitute or hire help is a strong indicator of a genuine business relationship rather than employment.
Financial risk, investment and opportunity for profit
Does the corporation carry real business risk — fixed-price contracts that can run over budget, its own liability insurance, capital invested in equipment — with a genuine chance to profit or lose money on the engagement? Or is the individual simply paid for time worked, insulated from the ups and downs a business normally bears?
What contract wording does and doesn’t buy you
A clause in the services agreement stating the individual is an “independent contractor, not an employee” does not settle the question. The CRA and the courts look at how the relationship actually operates day to day, not what the contract calls it. Practitioners see this misunderstanding constantly: a well-drafted contract is worth having, but it is evidence, not a shield.
What PSB status costs: the 44.5% calculation
This is the part that catches incorporated contractors off guard, because the number gets repeated everywhere without being shown.
No small business deduction
A normal Canadian-controlled private corporation (CCPC) earning active business income up to the $500,000 business limit uses the small business deduction (SBD) to bring its net federal rate down to roughly 9%. A personal services business is expressly excluded from claiming the SBD on its PSB income — none of that relief applies.
No general rate reduction
Corporate income that doesn’t qualify for the SBD normally still gets the general rate reduction, which brings the net federal rate down to about 15%. A PSB is denied this too. It is the one rate reduction available to every other kind of corporation, and it’s exactly the piece an open-web search can trip over: 15% is a real, current federal rate — it’s just the rate a PSB is specifically denied, not the rate a PSB pays.
The additional 5% PSB tax
On top of losing both reductions, a PSB pays an additional 5% federal tax on its PSB income, under the personal services business rules in the Income Tax Act. The CRA sets this out on its page covering obligations of a corporation carrying on a PSB.
The full stack: 28% + 5% + 11.5% Ontario = 44.5%
| Step | Rate | Running federal total |
|---|---|---|
| Basic federal Part I rate | 38% | 38% |
| Less: federal tax abatement | −10% | 28% |
| General rate reduction | Denied to a PSB | 28% (no reduction) |
| Additional PSB tax | +5% | 33% |
| Ontario general corporate rate | +11.5% | 44.5% combined |
“In Ontario, the combined federal and provincial rate on personal services business income is 44.5%.” That figure comes straight from the CRA’s own corporation tax rates page, applied to the PSB rules above — not from a rounded estimate. Compare that to the roughly 12.2% a normal CCPC pays on the same income under the small business deduction (9% federal plus Ontario’s 3.2% small business rate, for income earned in the first half of 2026), and the size of the trap becomes obvious.
The deductions you lose (this is the expensive part)
The rate is only half the story. The other half — and the part that actually does the damage — is what a PSB is and isn’t allowed to deduct.
What a PSB may still deduct
Per the CRA’s guidance, a personal services business may deduct: salary and wages paid to the incorporated employee, the cost of benefits or allowances provided to that person, and legal expenses incurred to collect amounts owed to the corporation. “A personal services business may deduct salary and wages paid to the incorporated employee, benefits and allowances provided to them, and legal expenses incurred to collect amounts owing — and very little else.”
What is denied
Office supplies, home-office costs, business travel, meals and entertainment, professional dues, software subscriptions, equipment, vehicle expenses, subcontractor fees — the ordinary operating costs every other small business deducts as a matter of course are not available to a PSB. It doesn’t matter that the money was genuinely spent running the business; if it isn’t salary, a benefit, or a legal collection cost, paragraph 18(1)(p) of the Income Tax Act denies the deduction.
Worked example: $200,000 of contract revenue, as a CCPC vs. as a PSB
The following is an illustrative example built from the verified rates above, not a published CRA figure — every corporation’s actual numbers will differ.
| Normal CCPC (small business deduction applies) | Same corporation, reclassified as a PSB | |
|---|---|---|
| Contract revenue | $200,000 | $200,000 |
| Salary paid to the incorporated employee | $120,000 (deductible) | $120,000 (deductible — still allowed) |
| Equipment, home office, professional dues, subcontracting | $40,000 (deductible) | $40,000 (spent — but not deductible under a PSB) |
| Taxable corporate income | $40,000 | $80,000 |
| Combined tax rate | ~12.2% | 44.5% |
| Corporate tax payable | ~$4,880 | ~$35,600 |
Same $200,000 contract. Same $160,000 of real, legitimate spending. A PSB reclassification adds roughly $30,720 in corporate tax on that one year alone — before a dollar of the remaining income reaches the shareholder personally. The tax rate is survivable on its own; losing every deduction and paying 44.5% at the same time is what actually does the damage.
The CRA’s personal services business pilot
What the pilot is and what CRA asks for
The CRA runs a dedicated personal services business pilot aimed specifically at incorporated contractors who may be misclassified. Corporations selected are asked to provide information about how the working relationship with their client actually operates — the same control, tools, substitution and financial-risk factors covered above — so the CRA can determine whether the PSB rules apply.
The penalty-free correction window
The strongest reason to act now rather than wait: the pilot has included a penalty-free correction window for participants who come forward and correct their filings, rather than waiting to be reassessed. We see these letters every week across the GTA, and the contractors who respond early are consistently better off than the ones who wait to see if it blows over.
What changed in 2025–26: enforcement, not the law
CRA guidance confirms the PSB definition and the 5% additional tax have not changed for 2025 or 2026 — recent edits to CRA pages were plain-language clarifications, not a change to the legislative requirement. What has changed is enforcement intensity. Budget 2025 proposes dedicated CRA funding — $77 million over four years starting in 2026–27, with $19.2 million annually on an ongoing basis — for a program specifically targeting PSB non-compliance and fees-for-service reporting, and the CRA has lifted its trucking-industry T4A reporting penalty moratorium starting with the 2025 tax year, per the CRA’s own page on workers who perform services through their own corporation. Read together, this is a rule that hasn’t changed paired with an enforcement effort that clearly has.
How to fix it before the CRA finds you
If any of the above sounds like your corporation, here’s the practical order of operations.
Step 1 — Re-paper the relationship. Where the facts genuinely support it, structure the engagement so it reflects an actual business relationship: control over methods and schedule, your own equipment, the ability to subcontract, and real financial risk. A contract can’t overwrite the facts, but a contract that accurately describes a real business relationship is worth having — see our guide on incorporation for the structural questions to work through first.
Step 2 — Pay it out as salary. Since salary is essentially the only deduction a PSB retains, drawing more of the corporation’s income as salary to the incorporated employee reduces the taxable income exposed to the 44.5% rate, even if it doesn’t change the underlying classification. It’s a mitigation, not a fix for the classification question itself.
Step 3 — Correct prior T2 returns. If past returns should have reported PSB status and didn’t, the Voluntary Disclosures Program is often the right route to correct them before the CRA’s pilot or a reassessment gets there first — it can mean the difference between a penalty and a clean correction.
Already been contacted by the CRA about your corporation’s status? Our CRA representation service handles the pilot’s information requests directly, so you’re not answering a compliance review on your own. And if your T2 itself needs a second look regardless of PSB status, our corporate tax filing service is the place to start.
We help incorporated contractors get this right
We work with incorporated IT consultants, engineers and project managers across Toronto, Markham and Richmond Hill every week — exactly the single-client contracting profile the PSB rules were written for. Whether you’re trying to confirm you’re not exposed, responding to a CRA pilot letter, or correcting past returns before the CRA gets there first, book a free 30-minute call and bring your contract and your T2 with you.
For context on the decisions around this one: if you’re still weighing whether to incorporate at all, see our guide to professional corporations; if your corporation is a normal CCPC and you’re deciding how to pay yourself, see salary or dividends from your Canadian corporation; for the broader list of what draws CRA attention to a corporation, see what triggers CRA audits; and for the mechanics of the return itself, see our Canadian corporate tax filing guide. If a CRA letter has already arrived about something else on the return, our guide to a CRA review letter covers that separately, and our piece on the Voluntary Disclosures Program walks through what coming forward voluntarily actually involves.
Frequently asked questions
A personal services business (PSB) is a corporation through which an “incorporated employee” provides services that, if the corporation didn’t exist, would reasonably be regarded as employment. The CRA taxes PSB income at a much higher combined rate and denies most business deductions.
Four conditions all need to apply: you’re a specified shareholder, you’d reasonably be regarded as an employee of the payer without the corporation, your corporation has fewer than six full-time employees, and the services aren’t provided to an associated corporation. Control, tools, ability to subcontract, and financial risk are the deciding factors on the “would be an employee” test.
44.5% — 33% federal (28% after the federal tax abatement, plus the 5% PSB tax) plus Ontario’s 11.5% general corporate rate. A PSB gets neither the small business deduction nor the general rate reduction.
Salary and wages to the incorporated employee, benefits and allowances provided to them, and legal expenses incurred to collect amounts owing. Most ordinary business expenses — office costs, travel, meals, subcontracting, equipment — are denied.
Yes, in principle — a corporation with six or more full-time employees throughout the year is not a PSB. In practice, this rarely works for a single-client incorporated contractor, since hiring five additional full-time staff isn’t a realistic option, and part-time help doesn’t count.
No, not on its own. The CRA and the courts look at how the relationship actually operates — control, tools, ability to subcontract, financial risk — not what the contract calls the arrangement. A contract is evidence, not a shield.
A CRA program that asks selected incorporated contractors for information about how their working relationship with their client actually operates, to determine whether the PSB rules apply. It has included a penalty-free window for participants who correct their own filings.
Past T2 returns can be reassessed to deny previously claimed deductions and apply the 44.5% combined rate to PSB income, plus interest and possibly penalties, going back to the years under review.
Yes — the Voluntary Disclosures Program is designed for exactly this, and coming forward before the CRA’s pilot or a reassessment reaches you is generally the better outcome.
Disclaimer: This article is general information, not personal tax advice. Whether the PSB rules apply to your corporation depends on the specific facts of your working relationship with your client, not just the four conditions in outline. Have a CPA review your actual contract and working arrangement before relying on any of the above.