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.”
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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
