Independent contractors in the oil patch typically use a corporate structure because it allows oil and gas companies to offload some of their risk. For instance, it gives them greater flexibility with layoffs and reduced severance payments.
While some risk transfers to the contractor, the corporate structure provides a number of benefits, including creditor protection, limited liability and reduced income tax rates.
Under a corporate structure the first $400,000 of income is taxed at 11% in Manitoba.
In Saskatchewan, the first $500,000 is taxed at 13%; in Alberta, it’s 14%. A tax deferral is achieved when after-tax earnings are kept in the corporation and distributed later to the shareholder via dividends.
Changes to PSB tax rates
On October 31, 2011, the federal government proposed legislation that may impact how an independent contractor is taxed if he or she operates under a corporate structure and is classified as a Personal Services Business (PSB).
Although PSB rules have been part of tax law for some time, the impact of being classified as a PSB has intensified.
A PSB is a corporate employee. In this case the relationship between an independent contractor and an oil company mirrors that between an employer an employee. PSB status means corporate income is taxed not at 11% or 13% or 14%, but 28%.
PSB expenditures are limited to an employee’s valid deductions. These include meals, travel and wages.
Is your client a PSB?
There are no hard-and-fast rules to determine if PSB classification applies to an independent contractor. It typically depends on case-specific facts. Canada Revenue Agency (CRA) relies on the following four criteria:
How much control does the independent contractor have over the work? An employee would have little control, while an independent subcontractor would have more.
Chance of loss.
If a mistake is made on the job, is the independent contractor responsible for making it right — and incurring the associated costs? An employee may be reprimanded but should not be out of pocket for the mistake.
Ownership of tools.
Does the company provide tools for the job? Independent contractors would provide their own while an employer would supply them for employees.
Employees are integrated into the operations of their employers. For instance, they may have a pension plan or company issued uniforms; independent contractors would have their own. Another test of integration is whether there is “enduring value.” Employees who would hurt the success of the company if they left have enduring value; in constrast, independent contractors often don’t have second assignments, and so aren’t critical to the company’s success.
The more independent contracts someone enters into, the more likely CRA will see him or her as a contractor rather than a PSB.
In the past, if a relationship was deemed a PSB and the contractor conceded his or her expenditures were limited, the income tax implications were bearable. The corporate tax rate would only be 15%.
When coupled with the personal tax rate, the overall tax was within 1% of the highest rate of 46.4% in Manitoba, 44.7% in Saskatchewan and 39% in Alberta.
Being classified as a PSB after the legislative changes means the rate will increase to 55.58% in Manitoba, 51.33% in Saskatchewan and 45.78% in Alberta.
Stino Scaletta is a tax specialist at MNP LLP.