Taxman cracks down on IT consultants

Peter Kovessy
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Government ignoring committee’s call to recognize realities of ‘modern labour market’

Thousands of local IT consultants are facing hefty tax reassessments as the Canada Revenue Agency reexamines their relationship with staffing agencies that help connect them to the federal government, experts say.


In recent months, the CRA has started “aggressively” auditing these incorporated businesses and ruling their role is more like an employee of a staffing firm than an independent contractor.

The financial stakes for these consultants are said to be high, with some facing reassessed tax bills of up to $50,000, say those involved in the fight with CRA.

If these businesses are deemed to be what the tax agency terms “personal services businesses,” they can no longer claim business expenses – such as office space, supplies and training – as deductions on their taxes. It also means they’re no longer eligible for the favourable small-business tax rate, adding a further financial strain.

“It can have such a significant impact in this town,” says Doug McLarty, managing director of accounting and financial services firm McLarty & Co.

While the frustrations of IT consultants may currently be directed at the CRA, a 1960s-era CFL coach may actually be at the root of the problem.

Ralph Sazio, who led the Hamilton Tiger-Cats to three Grey Cup championships, felt he would be better off tax-wise if he incorporated himself and contracted his services to the football club, says Gowlings partner and tax lawyer Mark Siegel, who represents a “fair number” of IT consultants fighting their reassessments.

He says the tax agency took the case to court and lost, prompting new rules that prevented individuals who incorporate themselves – but perform the functions of an employee – from realizing the tax benefits of a small business.

Government downsizing in the 1990s resulted in many federal bureaucrats becoming consultants to their former employer, especially in the IT sector. Rather than dealing with thousands of individual contracts, the government moved to a relatively small number of standing offers with staffing firms, which in turn subcontracted the consultants.

But Mr. Siegel says the CRA decided in the early 2000s that the consultants were more like employees than independent contractors of the staffing firms, which were then on the hook to make CPP and EI contributions.

To avoid these costs, many staffing firms then required consultants to be incorporated companies if they wanted work, according to Mr. Siegel.

But in 2009, the CRA started taking a different view of many of these independent corporations, observers say.

“They are reassessing these (individuals) – mainly IT consultants – who have created corporations (and) are providing their services, generally, through a staffing agency to federal government departments,” says Mr. Siegel.

“They’re between a rock and a hard place. If the assessment were to come along, a normal person would say, ‘I won’t be incorporated anymore.’ But then the staffing agencies won’t hire them.”

Jennifer Smith, an executive director in the Ottawa tax practice with Ernst & Young LLP, says incorporated individuals deemed to be personal services businesses face a double financial hit.

First, they can no longer deduct normal business expenses incurred while earning revenues.

They’re also ineligible for the favourable 15.5-per-cent tax rate on the first $500,000 of active business income, which is substantially lower than what an individual is taxed.

The CRA weighs several factors in determining whether an incorporated individual is an employee or an independent contractor, such as the degree of financial risk taken, level of control, and the opportunity for profit.

Mr. McLarty adds contractors who do the bulk of their work at a single department are at a higher risk than those with multiple clients.

Federal politicians are aware of the problems caused by the CRA’s new interpretation.

In June, the House of Commons finance committee released a report calling on the government to change the Income Tax Act to reflect “the realities of the modern labour market, particularly in terms of small information technology companies, in order to ensure tax fairness for those small business owners who are deemed to be ‘incorporated employees.’” The recommendation has so far been ignored.

Those representing the affected IT firms say they’re simply seeking clarity for their clients.

“These people are are facing tax bills they can’t pay ... (the CRA is) destroying entrepreneurship in the IT sector,” says Serge Buy, a lobbyist for CABiNET, which represents IT professional service providers in the National Capital Region.

“There should be clear rules that allow you to establish your business practices in a stable way.”


Common-law tests of whether an individual is an employee or an independent contractor:


-The level of control the employer or hirer has over the worker's activities;

-Whether the worker provides his or her own equipment;

-Whether the worker hires his or her own helpers;

-The degree of financial risk taken by the worker;

-The degree of responsibility for investment and management undertaken by the worker;

-The worker's opportunity for profit (or risk of loss) in the performance of his or her tasks; and

-The intention of the parties, as expressed in the relevant documentation and by their actions.

Source: Ernst & Young

Organizations: Hamilton Tiger-Cats, Ernst Young, House of Commons

Geographic location: Ottawa, National Capital Region

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Recent comments

  • Peter Wall
    January 21, 2013 - 09:21

    This whole thing is so backwards, it is nucking futs! Frankly, every person should be "in business" for themselves. The whole notion of employer/employee should be scrapped. What we have here is a view of the country as envisioned through the eyes (and blinders) of bureaucrats. Like that song from the "Rolling Stones", "Under my Thumb!" Bureaucrats have and continue to manipulate people and money simply for appearances and the vote. Indeed, I think most do not even realize how backward their decisions are. For example, who pays for EI? They would have you think an "employee" pays a certain amount from their salary and the company that hired them 1.4 times that amount, but when you get down to the nitty-gritty of it, everybody pays for EI because it is a "business" expense whether remitted to the government on behalf of the employee or remitted directly. The company must price its goods and services to address that additional cost, so anyone using those goods and services pays for EI! Every Canadian should have an equal opportunity to "work in government", that is "to contribute to Canada!" All government positions should be "elected" or "under contract for one year with a max. of two extensions, each of one year." The public service as we know it today should be gutted - get back to the reality of existence. The business elite clearly understand the fact that companies do not pay taxes - they just move money from the pockets of people to government - and they could care less about how government "for the people by the people" puts the screw to those people! Instead of going after those who are trying to make and grow a business for themselves, fix up the nutty tax system such that each dollar earned by anyone is taxed exactly the same way and for the same amount!

  • Daniel
    August 11, 2012 - 14:05

    The rules for PSB as defined above are out dated and don't reflect the realities of independent IT contractors and consultants. Let me iterate. -The level of control the employer or hirer has over the worker's activities; If I want a house built, I want the rooms laid out a certain way, I want the contracting company to make it look a certain way. However they come to that look or design is up to them. But, I will raise hell if it doesn't look like I paid if I am spending 100,000s of dollars. As a Software Consultant, the client wants things a certain way and completed to certain specs. I will do this as they expect, otherwise I would expect them to not use my services in the future. How I do it, the methods I write, the code I write, is up to me. -Whether the worker provides his or her own equipment; Outdated. While, IT consultants do have their own equipment and can use it at times. The vast majority of systems are worked on in a controlled environment. Big systems can't generally be taken offline to work. The threat of virus and other security considerations means it's impossible to use your own equipment while at a client site. -Whether the worker hires his or her own helpers; How can I ever grow my business if I can never start with only myself? It would be a terminal risk to start with multiple employees before I even got off the ground. This will kill entrepreneurship (especially small startups) in IT in Canada. -The degree of financial risk taken by the worker; As a business owner, if I can avoid financial risk - I will. Technology has made the barrier to entry on starting a business very low. Many successful IT companies have started this way for less than $100 and have grown to be successful. My consulting business start up costs have been in the thousands. Without clients I would consider these expenses and others as contributing to a loss. -The degree of responsibility for investment and management undertaken by the worker; -The worker's opportunity for profit (or risk of loss) in the performance of his or her tasks; and As far as any contracts go, the risk is that you haven't lived up to expectations and the contract is terminated. As an entrepreneur selling anything using modern technology, the biggest loss is time. A friend spent a year of his life developing software that never sold. He was a one man shop and it couldn't get off the ground. With consulting, you are selling your services - if you can't sell your services you will be out of business soon enough. -The intention of the parties, as expressed in the relevant documentation and by their actions. The intention is to be a consultant, and provide specialized skills (incl. technical knowledge), that cannot be provided internally by an organization. If I could build my own house, I would. I can't so I hire the services of experts. My mother could cut her own lawn if she was able to. She can't so she hires a company to do so.

  • MM
    July 31, 2012 - 12:51

    Is there any update so far regarding this issue, please share?

    • Linda
      July 31, 2012 - 16:03

      Revenue Québec revised the criteria for IT consultants in May 2012, all cases who were deemed to be PSB got reversed. Now, we are waiting for CRA to follow good example from Revenue Québec and to provide clarity on the rules.

  • Mark
    November 19, 2010 - 19:03

    The problem is that many Ottawa IT Consultants are de facto "employees" of the departments or agencies that employ them. They spend 230+ billable days per year on a single client site via a single Head-Hunter company....sometime for years at a time. That makes you a Contractor (non-benefit employee) - not a Consultant (Subject Matter Expert providing "As Required" services). IT Consultants need to build their business to work on multiple projects for multiple departments via different Head-Hunter companies within a single Business Year in order to keep themselves "safe" from these CRA reviews. Another option is to bring in some IT Juniors and new Grads to work on projects via your Incorporated Company (even if only as "Summer Staff"). You get to make some Margin on their work - and there's no question of you being a "Personal Services Business" if the CRA comes a knocking.

  • DJ
    November 18, 2010 - 15:48

    I am not sure why they are targetting the hiring firms. The hiring government agency treats a contractor exactly like an employee. They do it to avoid paying benefits, such as the very lucrative government pension, plus health benefits. The layers of incorporation that were implemented is a joke and the same government that is targetting consultants is the same government that drove this structure. Pathetic.

    • Rose Norton
      August 15, 2012 - 14:49

      If agree; if I was one of the many former employee of the federal government who were terminated back in the 80's and then rehired as contractors via these HR firms I would try to get a class action law suit going against the government agencies. The agencies are the de facto employer, not the HR firms. In many cases, there is no possible way that the relationship between the government agency and the so-called "contractor" is anything other than an employment relationship as laid out in the Canada Revenue Agency's guide "Employee or Self-employed."