When a Consulting Contract Didn't Match the Work Being Done

The situation

Analyn worked as a police sergeant in Hamilton, and several years earlier had built a second income stream advising organizations on emergency-preparedness and safety-compliance training. She incorporated the work, and her spouse Femi, a software developer, became the corporation's other shareholder and director, handling invoicing and the books on evenings and weekends.

For two years running, almost all of the corporation's revenue came from a single relationship: a mid-sized manufacturer where Analyn worked closely with a operations manager named Kwame, coordinating a plant-wide safety training overhaul. The engagement grew from a short project into something closer to a standing role. Analyn was on-site most weekdays, used a company laptop and badge, reported progress to Kwame the way a staff member would, and had no time left to take on other clients even if she had wanted to.

The corporation had a written independent contractor agreement in place from the start. It described Analyn's company as an independent business, free to set its own hours, use its own equipment, and take on other engagements. On paper, that agreement looked like a normal consulting contract. In practice, almost nothing about the day-to-day arrangement matched it.

What the audit found

The Canada Revenue Agency selected the corporation for a review after a routine matching check flagged that nearly all of its income came from one payer over consecutive years. The audit that followed was not looking at whether the corporation had underreported income — it had not. It was looking at whether the corporation was, in substance, a personal services business.

Under the Income Tax Act, a corporation is treated as a personal services business when the person actually performing the work would reasonably be considered an employee of the company paying for the services, if the corporation did not exist. The label on the contract does not settle the question. What matters is the real relationship: who controls how, when, and where the work is done; who owns the tools and equipment used; whether the worker bears any real financial risk or chance of profit beyond a wage; and whether the arrangement is exclusive or the worker is genuinely free to build a client base.

Measured against those factors, the CRA auditor concluded that for both years under review, Analyn's corporation looked like an incorporated employee rather than an independent business. She worked fixed hours on the client's premises, used the client's equipment, took direction from Kwame in the way a supervisor directs staff, and had no other clients or realistic ability to take one on. The written contract's language about independence did not match any of that.

The consequence of a personal services business finding is severe. A corporation classified this way loses access to the small business deduction, which normally taxes active business income at a preferential rate, and it can only deduct salary and wages paid to the incorporated employee plus a narrow list of other costs — not the ordinary range of business expenses a genuine consulting corporation would claim. The result is corporate tax calculated at close to the top rate on income that had been taxed, filed, and planned for as if the small business deduction applied. Across the two years in question, the CRA's proposed reassessment, including denied deductions, added tax, and accumulated interest, came to roughly $270,000.

What we did

1. Reviewed the full audit file and the underlying facts year by year. A personal services business finding is not automatically the same for every year under review. We went through the contract, the invoicing history, the client correspondence, and Analyn's actual working pattern to see whether the two years were really identical, or only looked that way from the outside.
2. Found a real difference between the two years. Partway through the second year, on Femi's initiative, the corporation had begun invoicing the manufacturer for defined training modules delivered rather than for hours worked, had taken on a second, smaller client for after-hours consulting, and had shifted Analyn to using her own laptop for most of the work. None of that had been done with the audit in mind — it happened because the original hourly arrangement was inefficient — but it mattered enormously to the legal analysis.
3. Filed a Notice of Objection distinguishing the two years on their facts. Rather than treat the reassessment as one indivisible problem, we built the objection around the argument that the first year showed genuine employee-like integration, while the second year, after the changes, showed real elements of an independent business: a second client, deliverable-based billing, and use of the corporation's own equipment.
4. Assembled supporting evidence for the appeals officer. This meant pulling together the second client's invoices, correspondence showing Analyn declining certain requests from Kwame as outside the agreed scope, and records showing the corporation carried its own liability insurance and bore the cost of redoing work that did not meet the manufacturer's standards — a real chance of loss, not just a wage.
5. Negotiated a resolution with the CRA Appeals Division. The appeals officer agreed that the second year's facts did not support a personal services business finding, given the added client, the billing structure, and the use of the corporation's own equipment. The first year's reassessment stood, because none of those changes existed yet during that period.
6. Rewrote the corporation's contract template and working practices going forward. The new agreement requires deliverable-based invoicing rather than hourly billing tied to a single client, sets out the corporation's right to subcontract and to work for other clients, and specifies that Analyn's company supplies its own equipment. Just as importantly, we walked Analyn and Femi through why the practice, not just the paperwork, has to match those terms — a written clause that the corporation can subcontract means nothing to an auditor if it never actually does.

The outcome

The second year's reassessment, worth roughly $105,000 of the original $270,000, was vacated. The first year's reassessment stood, leaving the corporation liable for roughly $165,000 in additional tax and interest — a real and painful cost, and one that reduced Femi's ability to draw dividends from the corporation for the following two years while the balance was paid down on an arrangement with the CRA.

That outcome was not a win. The first year's facts genuinely supported the CRA's position, and no amount of after-the-fact argument was going to change what actually happened on-site during that period. What contained the damage was that the changes Femi made partway through the second year — for reasons that had nothing to do with tax risk — turned out to matter under the personal services business test, and there was contemporaneous evidence to prove it. Had the corporation continued billing by the hour, working exclusively for one client, and using that client's equipment straight through both years, the full $270,000 reassessment would almost certainly have stood.

Going forward, the corporation now takes on a second and third client deliberately, invoices most engagements by deliverable rather than by the hour, and keeps a simple annual file — client list, equipment used, subcontracting activity — that would let it demonstrate independence on short notice if it is ever reviewed again.

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