A version of the following article appeared in the most recent edition of the HLA Journal.
An employee, for income tax purposes, cannot deduct many expenses that a person in business for him- or herself can. On the other hand, a CCPC that carries on an active business can claim the small business deduction in respect of income from that business. Assuming that a worker does not wish to be treated as an employee, can he or she get the tax benefits of a self-employed person and the small business deduction by providing services through a corporation? The answer is “no”, if the personal service business (“PSB”) rules apply.
J. McCarty Inc. v R, 2015 TCC 201 (http://canlii.ca/t/gkpmj) [“McCarty”] is a recent case that considers the PSB rules in detail. The case is also useful for understanding the approach that will be adopted by a Tax Court when trying to distinguish between an employee and an independent contractor because applying the PSB rules entails making just such a distinction.
Some Tax History
A little local tax history is in order. Ralph Sazio became the head coach of the Hamilton Ticats in 1962. Rather than pay tax at the rates applicable to individuals, Mr Sazio, “on the advice of his auditor and solicitor”, incorporated a corporation, which entered into a contract with the Ticats to provide Mr Sazio’s services as a coach. The corporation earned fees for Mr Sazio’s coaching services and payed taxes at a lower rate. The Minister of National Revenue reassessed Mr Sazio to include the fees in his income, but the Exchequer Court held that the Minister could not ignore the legal relationships created by the parties: the Minister could not impose tax on the “substance” (Mr Sazio was really an employee, said the Minister) over the “form” (the corporation was carrying on business as a provider of coaching services, said the taxpayer). Mr Sazio 7, the Minister 0. See Sazio v MNR, [1968] C.T.C. 579, 69 D.T.C. 5001, [1969] 1 Ex. C.R. 373 (Ex.).
The Department of Finance responded to this decision with the PSB rules. Under the rules, a corporation that carries on a PSB as defined in s 125(7) of the Income Tax Act (Canada) (the “Act”) pays tax on the income derived from the business at ordinary corporate rates (rather than the small business rate) and, in computing income for the purposes of the Act, can deduct only those expenses that an employee would be entitled to deduct (per s 18(1)(p)).
McCarty
Mr McCarty was a construction project manager with 35 years’ experience as such. In 2001, he incorporated the corporate appellant (“CJM”) to carry on business as a provider of project management services. In 2007 and 2008, CJM provided services to “MEG” on a couple of large tar sands construction projects. CJM did not have any other significant clients in those years (it had more than enough work from MEG). The Minister reassessed CJM for the years to deny it the small business deduction and the expenses it claimed from its MEG income (other than those permitted by 18(1)(p)) on the basis that CJM was carrying on a PSB.
S 125(7) defines a “personal services business” to be a
… business of providing services where
(a) an individual who performs services on behalf of the corporation (in this definition and paragraph 18(1)(p) referred to as an “incorporated employee”), or
(b) any person related to the incorporated employee
is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation …
The definition then lists a couple of exceptions to this rule, which exceptions were not relevant to the case.
The court noted that, under the agreements between MEG and CJM, CJM was required to provide the contracted services using Mr McCarty unless MEG provided its consent in writing. That is, CJM could not hire whomever it pleased to provide the services. CJM was paid an hourly rate for its services, capped at 200 hours per month, but the cap was often exceeded because of the size of the projects.
On the facts, the court had no trouble concluding that Mr McCarty was a specified shareholder of CJM and that he was the “incorporated employee” referred to in the PSB definition. The question, then, was whether Mr McCarty “would reasonably be regarded as an officer or employee of” MEG “but for the existence of” CJM. To answer the latter question, the court directed itself as follows:
[31] Clearly, the phrase “but for the existence” requires the Court to disregard the actual relationship of the parties, MEG and CJ[M], and determine what would have been done had a different relationship been set up as between Mr. McCarty and MEG.
[32] As noted by Sharlow J. in Dynamic [2005 FCA 2011], the hypothetical question is a manifestation of the wording of paragraphs (b) and (c) of the definition. In considering whether Dynamic carried on a personal services business, the Court said that the principles in Wiebe Door Services Ltd. v. Canada (Minister of National Revenue – MNR), [1986] 3 FC 553 (FCA) [Wiebe Door] and 671122 Ontario Ltd. v Sagaz Industries Canada Inc., 2001 SCC 59 (CanLII), [2001] 2 SCR 983 [Sagaz] assists in characterizing whether the individual would reasonably be regarded as an employee of a third party purchaser of the services provided by the individual if his/her corporation’s role, rights and obligations were disregarded.
[33] In Sagaz, the Supreme Court of Canada said that the central question is whether the individual who has been engaged to provide services to another is performing them as a person in business on his or her own account.[12] To decide that question, it is necessary to look at the factors, enunciated in Wiebe Door, of control, tools, whether the worker hires helpers, chance of profit and risk of loss. The relative weight of each of those factors depends on the facts of the case. Before turning to those factors, it is necessary to determine if intention is a factor in the application of the provision pertaining to personal services businesses.
After concluding that the intention of the parties to the relationship as expressed in their agreement was irrelevant (at para. 42), the court then proceeded to consider the factors per Wiebe Door.
Control
Did MEG have the right to control the manner in which Mr McCarty performed his activities as a construction manager? The court concluded that, on the whole, the evidence established that Mr McCarty was “mostly self-directed in pursuit of the desired results”. The Crown tried to argue that the provisions of the agreements signed for the relevant years that set out the services to be provided showed that MEG dictated the work to be performed. The court found these provisions to be “neutral” because it could equally be interpreted as Mr McCarty having the ability to select the work that he performed for MEG.
Mr McCarty was required to report regularly to an MEG employee, but the reports were in the nature of monthly updates, and the MEG employee was relatively inexperienced and could not provide meaningful direction to Mr McCarty.
The agreements provided that Mr McCarty was to provide services during MEG’s normal business hours. This requirement suggested a degree of MEG control, but Mr McCarty testified that, in fact, given the size of the projects he managed, he was effectively on call 24 hours per day. MEG, then, did not dictate the hours of work, which suggested Mr McCarty was not an employee.
Under the agreements, Mr McCarty was not required to work for MEG exclusively. The court concluded that this right argued against employee status even though CJM derived all of its revenue from MEG in the years in question.
The court concluded that, on the whole, MEG did not exert control over Mr McCarty, which suggested he was not (or would not have been) an employee.
Integration
The integration factor asks whether there is “mutual reliance” between the payor and the worker. The court noted that CJM had provided services to other organizations before entering into the agreements with MEG. For a short period during the years in question, CJM provided services to a corporation related to MEG, and CJM continued to exist after those years. The court noted that other contractors, including other construction managers, worked for MEG. The court found that “It is reasonable to conclude that at the relevant time, the services [Mr McCarty] provided to MEG would have been provided as an independent contractor and was not integral to MEG’s business.”
Tools
MEG reimbursed CJM for some but not all of its expenses. MEG also provided some food and lodging, a cell phone, a computer and some software that Mr McCarty needed to provided services. “The equipment provided by CJ[M] or him consisted of a brief case, pens, pencils, stationery, clothing for chemical spills and his personal cell phone. He also used his own vehicle when at Christina Lake to tour the jobsites and go to the site office” (para 61).
The court concluded the tools factor “leaned slightly” toward employee status.
Helpers
There was evidence that Mr McCarty’s wife helped with certain administrative tasks associated with CJM’s business (invoicing and accounting), but the contract with MEG specified that Mr McCarty was to provide all services. Moreover, CJM did not claim payroll expenses for Mrs McCarty or his daughter (who was also supposed to be an employee of CJM). “The evidence relating to this factor leans towards an employee status” (para 68).
Chance of profit and risk of loss
“The chance of profit and risk of loss factor is intended to reveal whether the activities of Mr. McCarty provided him with the opportunity for profit in the performance of his activities entailing the kind of risks that are more typical of those borne by a business entity rather than an employee.” (para 69).
Did Mr McCarty (CJM) have a chance at profit? The court stated (at para 76):
The normalcy of an hourly rate in that line of business [construction] and the manner he was remunerated (hourly rate, the cap, no fringe benefits similar to MEG’s employees, the delays in payment and the expectation of performing warranty work), diminishes the characterization that he would reasonably be regarded as an employee.
These facts, the court said, suggested independent contractor status, and the court also accepted that CJM carried liability insurance (at its cost), which also suggested independent contractor status.
Conclusion
The court concluded its analysis by finding that “but for the existence of [CJM], Mr. McCarty would reasonably be viewed as a person performing services for MEG as a person carrying on a business on his own account“ (para 85). The PSB rules, then, did not apply, and so CJM was entitled to the small business deduction and to the business expenses it had claimed.
Whether someone is an employee, or whether the PSB rules apply, is an inquiry that will always be highly fact-driven. Reviewing the case law in this area, however, will provide useful guidance on what situations will attract the attention of the CRA and the factors the court will consider in conducting its analysis.
