When you start up a business and allow it to grow, you start to make a profit and want it to grow even more. That’s human nature, and it’s a great way for a business to progress. As that occurs however, you will also find yourself with all manner of advice coming your way. Fellow business owners, friends, family, do-gooders, they will all be telling you that you should incorporate your business.

Is this a truth?

It’s true that with most pieces of well-meaning advice you need to be cautious, but some issues are worth taking notice of. For instance, did you know that if you choose to incorporate your business, there are several benefits which could come your way?

You might like the idea of being unincorporated to some degree, e.g. flexibility, but you could be missing out on a fair amount of money saved in terms of your taxes.

If you choose to incorporate your business in Canada, you will be able to take advantage lower taxes from a corporate point of view, and you can also choose to sell shares in your business in a tax-free way. This isn’t the full story however. When incorporation was invented, this was aimed at businesses who were investing in the economy, taking on staff and paying them salaries etc. That is not necessarily your situation.

If you are a small business and you do not have employees, i.e. it’s just you, you could be named as a ‘Personal Service Business’ instead. This is because you do not have staff, and means that you might not be able to utilize the business deduction that most small businesses in Canada can. You won’t be able to take expenses and deduct them in any special way, which means you’re not likely to receive much in the way of benefit. 

So, what you need to know is whether you can incorporate your business and avoid having this label of a Personal Service Business being sent your way.

Luckily, there is a way.

How to Avoid Personal Service Business Labeling

The CRA will look at your business and decide whether it falls under this label or not. In order to avoid it you need to be seen in their eyes as a self-employed person, and not an employee of a small business. In order to make this decision, three areas are examined. This includes a test for economic reality encompassing:

•    Control - You must be able to show that you take orders from no one, you control the management of the work, etc.

•    Tool ownership - You need to show that you own the tools required for the business you do

•    Risk of profit and loss - Every business has the potential for loss, and you need to show that you have risk within your business, and that you also have potential for profit

You will also need to undergo an organization test or an integration test. This basically decides whether or not you are dependent on the business you do. The best way to show this is to have more than a few companies, which you need to send invoices to over the course of a year. This shows that you are not an employee, but indeed self-employed.

The final test is a specific results test. This means that you are the one performing several different tasks which business survival depends upon, and that you are not only responsible for one task, i.e. as an employee would be.

If you can prove all of the above, incorporation is certainly a good option to look at, but you should always seek to reliable advice from an experienced accountant before making any financial decisions within your business.

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- Written by: Jag Bath