What expenses can a personal services business still deduct?

The rule is a short list of what survives, not a long list of what is denied

The Income Tax Act does not list the expenses a personal services business loses; it lists the only ones it keeps, and everything absent from that list is gone. Paragraph 18(1)(p) says that in computing income from a personal services business, no deduction may be made except for four things: salary, wages or other remuneration paid in the year to the incorporated employee; the cost of any benefit or allowance provided to that incorporated employee; amounts spent in selling property or negotiating contracts that would have been deductible to a commissioned employee under the employment-expense rules; and legal expenses of collecting amounts owed for services the corporation rendered. That is the whole permitted list.

Two boundaries make the rule narrower than it first sounds and, in one respect, wider. It applies only to income from the personal services business, so a corporation with a second, genuine business or with investment income deducts normally against those streams; the restriction follows the PSB income, not the corporation. And the list turns on payments to the incorporated employee, the individual whose work makes the corporation a PSB in the first place, so what the corporation spends on that person is largely safe and what it spends on anything else is largely not.

The reason for the design is the reason for the regime. A PSB is a corporation standing where an employee would otherwise be, and an employee cannot deduct rent, software, marketing or a car against a salary. Parliament's answer was to give the corporation the same deductions an employee would have had, plus the wage itself, and nothing more. If you have not yet read why a corporation ends up with the label, what is a personal services business covers the tests; this page assumes the label and asks what is left.

What survives, item by item

Salary is the deduction that carries the weight, and it is unrestricted in the way the others are not. Every dollar of salary, wages or bonus the corporation pays to the incorporated employee in the year, run through payroll with source deductions withheld and remitted, comes off PSB income in full. Because salary is deductible without limit, a PSB can reduce its taxable income to nearly nothing by paying its profit out, which is why this page ends where it does.

Benefits and allowances to the incorporated employee are the second item, and they are broader than owners assume. The cost of a taxable benefit the corporation provides you, a company-paid health plan, a vehicle you use personally and report as a standby charge, an allowance for expenses, is deductible to the corporation because it is remuneration in another form; the flip side is that the benefit is income to you, reported on your T4. This is the door through which some spending can be rerouted rather than lost, and it is discussed at the end.

The third item is the employment-expense band: amounts the corporation spends in selling property or negotiating contracts that would have been deductible to a commissioned salesperson had you been an employee required to pay them. In practice that covers a narrow set of costs tied to winning work, and certain travel, in the way a commissioned employee can claim them, subject to the same limits and conditions employees face. It rarely amounts to much for a consultant or contractor whose expenses are mostly tools, space and software. The fourth item, legal fees to collect unpaid invoices, is straightforward and, with luck, never needed.

What is denied, side by side with what survives

Everything not on the list is denied, and the list of casualties is the ordinary overhead of a one-person business. The table shows the usual items, and the right-hand column reads the way it does for a reason.

Three of those rows surprise people every time. Capital cost allowance is denied along with everything else, so the laptop and the desk are not written off over time; they are simply not written off. The accountant's fee for preparing the corporate return is denied, which means the corporation pays tax on the money it spent to pay its tax. And vehicle costs are denied except to the extent an employee could have claimed them, which for most contractors driving to a single client site is nothing, because an employee's commute is personal.

None of this makes the spending improper. The corporation may still pay for its software, its insurance and its accountant, and the payments are real expenses in its financial statements; they are simply added back when taxable income is computed. What the denial does is convert each dollar of overhead into a dollar of taxable PSB income at roughly 44.5 per cent, which is the number to hold in mind when reading the rest of the page.

HST input tax credits are unaffected by the income-tax denial

The HST side of your corporation does not know what a personal services business is. Input tax credits are governed by the Excise Tax Act, which asks whether the corporation acquired the expense for use in its commercial activities, and providing taxable services to a client is commercial activity regardless of how the Income Tax Act characterizes the profit. The HST on the software subscription, the accountant's invoice, the business-use share of the home internet and the laptop remains recoverable on the corporation's HST return exactly as before, subject to the ordinary limits, such as the half restriction on meals.

That matters practically for two reasons. First, it means the receipts still have to be kept and coded properly even though the income tax deduction is gone; abandoning the bookkeeping because the expense is denied throws away the HST recovery, which on a year's overhead is real money. Second, it means the corporation's HST filings continue to look like a business's filings, which they are, because for HST purposes nothing changed. A PSB reassessment does not ripple into your HST account, and an HST audit does not turn on PSB status.

The bookkeeping consequence: two profits and one tax return

A personal services business has an accounting profit and a taxable income that no longer resemble each other, and the books have to be kept so that both can be produced. The financial statements record every expense the corporation actually incurred, because they are true and because the HST return and any lender want them that way. The corporate return then starts from that accounting profit and adds back each denied expense on the reconciliation schedule, which for a PSB is most of the expense lines. Taxable income ends up close to revenue minus salary, and the corporate tax is computed on that.

We set the chart of accounts up so the split is mechanical rather than a year-end reconstruction: remuneration and benefits to the owner in one group, the narrow employment-type items in another, and everything else in a third that is expected to be added back. Reasonableness still applies to what remains, and the payroll must actually be run, with T4s, CPP and remittances, because salary that is merely booked as a payable and never paid is not remuneration paid in the year. A corporation that treats the PSB rules as a year-end adjustment rather than a bookkeeping design tends to discover in April that the salary it meant to pay was never processed.

Keep the receipts for the denied items anyway, and not just for HST. If the corporation later proves it was not a PSB for a year, or the finding is reversed at objection, those expenses become deductible again, and the file that supports them is the one you kept in real time. If the corporation stops being a PSB because the facts change, the same records support the ordinary deductions from that year forward.

Why paying salary is the deduction, and how to model the after-tax result

The one deduction with no ceiling is salary, so the working plan for a personal services business is to pay salary until there is almost no PSB income left to tax. Revenue comes in, the few allowed expenses come off, salary takes the rest, and the corporation's taxable income is a rounding amount. The denied overhead does not disappear in that plan, but it moves: either the corporation pays it and shows taxable income equal to those costs, taxed at roughly 44.5 per cent, or you pay it personally out of salary that has already borne your personal rate. Either way the overhead is paid with after-tax dollars, which is exactly the position an employee is in.

The model we build is a single page. Start with fee revenue and subtract the allowed items, any collection costs and the narrow employment-type band. Decide how much overhead the corporation will carry, and treat that amount as taxable at the PSB rate. Set salary equal to what remains, less a small buffer for timing, and compute your personal tax on that salary.

The total of corporate tax on the retained overhead plus personal tax on the salary is your all-in cost, and comparing it to what plain employment at the same fee would have cost tells you what the corporation is really doing for you. For most PSBs the honest answer is that it costs a little more than employment would, and the reason to keep it is commercial rather than tax. Choosing the salary amount and the year-end bonus timing is the subject of how the owner of a personal services business should pay themselves.

One refinement deserves an honest mention. Because the cost of a benefit or allowance to the incorporated employee is deductible, some overhead can be structured as remuneration rather than overhead: the corporation reimburses or provides the item, reports it as a taxable benefit on your T4, and you then claim what the employment-expense rules allow on your personal return, with a T2200 signed by your corporation as your employer. Where the conditions are genuinely met, a required home workspace or supplies you had to pay for, that route recovers part of the loss. Where they are not met, it merely converts a denied corporate deduction into taxable personal income, so it has to be tested item by item and not assumed.

The facts that decide how much all of this costs you are few: how large the denied overhead is relative to revenue, whether any of it fits the employment-expense band or the benefit route, whether the corporation has other income the restriction does not touch, and whether the PSB label is settled or still arguable on the facts. If CRA has already reassessed you, the rules on this page explain the add-backs on the notice, and what happens if CRA decides my corporation is a personal services business covers the timeline and your options. Either way, the corporate return has to be prepared on these rules deliberately, which is work we do inside Corporate Tax; a free 15-minute discovery call is enough to tell you whether your current books can produce the two numbers a PSB needs.