4 August 2009 External T.I. 2009-0320491E5 - Personal services business

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a series of expenses incurred by a personal services business is deductible under paragraph 18(1)(p) of the Income Tax Act (Canada).

Position: See response.

Reasons: See response.

2009-032049
XXXXXXXXXX André Gallant
(613) 957-8961
August 4, 2009

Dear XXXXXXXXXX :

Re: Personal services business

This is in response to your letter of May 1, 2009, and is further to our telephone conversation on July 16, 2009 (Gallant/XXXXXXXXXX ), regarding the deductibility of expenses under paragraph 18(1)(p) of the Income Tax Act (Canada) (the "Act") in computing income from a personal services business.

As we understand it, you envisage the following hypothetical situation:

1. Corporation A carries on a "personal services business" as defined in subsection 125(7) of the Act and provides its services to Corporation B, which does not carry on a personal services business. Corporations A and B are not related to each other, nor associated to one another.

2. The only two employees of Corporation A are the incorporated employee and his spouse. The incorporated employee provides the services to Corporation B, and the spouse only performs a limited amount of support services to Corporation A. The spouse is paid a limited salary reasonable for her services to Corporation A. The spouse performs no services directly to Corporation B. Corporation A carries on no business other than the personal services business.

3. Corporation A proposes to deduct the following expenses it would incur:

a. Salary paid to the incorporated employee;

b. Salary paid to the incorporated employee's spouse;

c. Contributions for the incorporated employee to a self-administered Private Health Services Plan as discussed in Interpretation Bulletin IT-339R2, Meaning of "Private Health Services Plan";

d. Contributions for the incorporated employee's spouse to a self-administered Private Health Services Plan as discussed in IT-339R2;

e. Car allowance (fixed monthly amount) paid to the incorporated employee;

f. Car allowance (fixed monthly amount) paid to the incorporated employee's spouse;

g. Contributions for the incorporated employee to an Employee Profit Sharing Plan, as discussed in Interpretation Bulletin IT-280R, Employees Profit Sharing Plans - Payments Computed by Reference to Profits;

h. Contributions for the incorporated employee's spouse to an Employee Profit Sharing Plan, as discussed in IT-280R; and

i. Expenses incurred for the purposes of negotiating contracts.

4. Corporation B proposes to deduct the fees it would pay to Corporation A, as well as any other amount listed in facts 3(c) to (i) above that it would pay on behalf of Corporation A.

5. The incorporated employee proposes to deduct the expenses he would incur for negotiating contracts under paragraph 8(1)(f) of the Act, as filed on a T777 with a T2200 prepared by either Corporation A or B.

You are asking us which of the expenses listed above could be claimed by either Corporation A and B as a deduction pursuant to paragraph 18(1)(p) of the Act, and whether the incorporated employee could deduct expenses for negotiating contracts under paragraph 8(1)(f) of the Act.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). We are, however, prepared to offer the following general comments, which may be of assistance.

Paragraph 18(1)(p) of the Act limits the expenses that may be deducted in computing income from a personal services business.

Since Corporation B does not carry on a personal services business, paragraph 18(1)(p) would not apply to it. The rules concerning the deduction of expenses in computing income would still, however, apply to Corporation B. For example, to be deductible under the Act, an expense must be for the purpose of earning income (paragraphs 18(1)(a)), not be on capital account (paragraph 18(1)(b)), not be for personal reasons (paragraph 18(1)(h)), and be reasonable in the circumstances (sections 67 and 67.1). It would be a question of fact based on a review of the contracts, documents and surrounding circumstances whether the amounts referred to in facts 3(c) to (i) paid by corporation B on behalf of corporation A would be deductible in computing corporation B's income.

Paragraph 18(1)(p) only applies to a corporation carrying on personal services business (i.e., Corporation A), and not to an incorporated individual. In order for the incorporated employee to deduct an expense in computing employment income, this expense must specifically be permitted by section 8 of the Act. If the expense is not allowed by section 8, it is specifically denied as a deduction by subsection 8(2) of the Act. For example, paragraph 8(1)(f) provides a deduction for a taxpayer employed in the year in connection with the selling of property or negotiating of contracts for the taxpayer's employer, where the taxpayer:

• Was required to pay the taxpayer's own expenses under the contract of employment;
• Was ordinarily required to carry on the duties of employment away from the employer's place of business;
• Was remunerated in whole or in part by commission or other similar amounts fixed by reference to the volume of the sales made or the contracts negotiated; and
• Was not in receipt of a travel allowance in the year that was excluded from the taxpayer's income under subparagraph 6(1)(b)(v) of the Act.

However, paragraph 8(1)(f) specifically excludes outlays, losses or replacements of capital or payments on account of capital. The expenses are also subject to the usual test of reasonableness (section 67).

Corporation A can deduct the following expenses pursuant to paragraph 18(1)(p):

• Salary, wages or other remuneration paid in the year to an incorporated employee of the corporation (subparagraph 18(1)(p)(i));
• The cost of any benefit or allowance provided to an incorporated employee by the corporation, and not simply the benefits and allowances covered by paragraphs 6(1)(a) and (b) of the Act. For example, although a retiring allowance paid to an incorporated employee may not be considered a benefit or allowance pursuant to paragraphs 6(1)(a) and (b), the retiring allowance would still be considered to be "any" benefit or allowance (subparagraph 18(1)(p)(ii));
• Any amount expended by the corporation for the purposes of selling property or negotiating contracts that would normally be deductible in computing income from employment of the incorporated employee had the expense been incurred by the incorporated employee (subparagraph 18(1)(p)(iii)); and
• Any legal expenses paid by the corporation to collect accounts receivable with respect to services rendered (subparagraph 18(1)(p)(iv)).

For any of these expenses to be deducted under paragraph 18(1)(p), it must also be established that the expense would be deductible to a corporation if it were not carrying on a personal services business (post-amble of paragraph 18(1)(p)). The rules concerning the deduction of expenses in computing income mentioned earlier also apply depending on the circumstances (e.g., paragraphs 18(1)(a), (b), (h), and sections 67 and 67.1).

It is noted that the expenses referred to in subparagraphs 18(1)(p)(i) and (ii) (e.g., salary, bonus) are only those expenses relating to an incorporated employee. An "incorporated employee" is described as "an individual who performs services on behalf of the corporation" by paragraph 125(7)(a) of the definition of "personal services business", which makes the description of "incorporated employee" also applicable to paragraph 18(1)(p). In the present case, the incorporated employee's spouse is not herself an incorporated employee. Therefore, any salary paid or benefits provided to the spouse would not be deductible to Corporation A under subparagraphs 18(1)(p)(i) and (ii).

The following expenses would be deductible to Corporation A pursuant to paragraph 18(1)(p) to the extent that, in accordance with the post-amble of paragraph 18(1)(p), the expenses would be deductible by Corporation A, if it were not carrying on a personal services business:

• The salary paid to the incorporated employee by Corporation A under subparagraph 18(1)(p)(i);
• Contributions by Corporation A to a Private Health Services Plan for the incorporated employee under subparagraph 18(1)(p)(ii) (see IT-339R2);
• The car allowance (fixed monthly amount) paid to the incorporated employee under subparagraph 18(1)(p)(ii);
• Contributions by Corporation A to an Employee Profit Sharing Plan for the incorporated employee under subparagraph 18(1)(p)(ii) (see IT-280R); and
• Expenses incurred for the purposes of negotiating contracts as described in subparagraph 18(1)(p)(iii).

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch