A Consulting Contract That Didn't Match How the Work Was Done

The situation

Gurpreet sold the manufacturing business he had built over three decades and, within a year of retiring, found himself bored. A specialist physician he had known for years, Yan, was struggling to run the administrative side of a growing clinic near Midland — scheduling systems, staff supervision, equipment purchasing, billing reconciliation. Gurpreet knew how to run an operation. He offered to help, and within a few months it had become steady work.

He and his wife Navdeep, who had handled the books for his old business, incorporated a small management consulting company. Gurpreet drew a modest salary and the corporation invoiced Yan's clinic monthly for practice-management services. A written consulting agreement described Gurpreet as an independent contractor, free to take on other clients, responsible for his own tools and working hours, and paid a flat monthly retainer rather than an hourly wage. On paper, it read like a standard consulting arrangement, and the corporation's income was taxed at the lower small-business rate available to active Canadian-controlled private corporations.

In practice, the relationship settled into something narrower. Gurpreet worked from an office inside the clinic four days a week, used the clinic's computers and phone system, reported to Yan directly on scheduling and staffing decisions, and — apart from one small unrelated project in the first year — did not take on other clients. The written contract and the daily reality had quietly drifted apart, and neither Gurpreet nor Navdeep thought much of it until a letter arrived from the Canada Revenue Agency.

What the review found

The letter opened a routine-looking audit of the corporation's tax filings for the prior four years. It did not stay routine. Partway through, the auditor's questions shifted from expense receipts to the structure of the working relationship itself: how many clients did the corporation actually serve, who set the hours, who supplied the equipment, who bore the risk of loss if the work went badly.

The CRA was testing for what the Income Tax Act calls a personal services business — a corporation that, despite its legal form, functions as an incorporated employee rather than an independent business. The distinction matters enormously. A genuine active business earning consulting income can access the small-business tax rate and deduct its ordinary operating expenses. A personal services business cannot. It is taxed at a much higher corporate rate and loses the ability to deduct most expenses beyond the individual's own salary, on the theory that if the person would otherwise be an employee, the corporation shouldn't be able to claim deductions an employee never could.

The test the CRA applies looks past the label in the contract to the substance of the relationship: how much control the payer exercises over the work, whether the worker could realistically profit or lose money from how the job was managed, who owns the tools, and how integrated the worker is into the payer's operation. Gurpreet's written agreement checked the boxes for independence. His actual working life — one client, clinic-supplied equipment, clinic-set hours, day-to-day direction from Yan — checked most of the boxes for employment.

The reassessment that followed was substantial. Across the four audited years, the CRA proposed denying the small-business rate and most of the corporation's claimed expenses, producing additional federal and provincial corporate tax, plus arrears interest, totalling roughly $850,000. It was, by a wide margin, the largest financial threat either of them had ever faced.

What we did

1. Pulled apart the four years individually rather than treating them as one block. The CRA's letter reassessed all four years the same way, but the underlying facts had not stayed constant. In the first year, the corporation had performed a separate short-term project for a different client, taken real financial risk on a fixed-price piece of work, and used its own equipment for part of the engagement. That year looked meaningfully more like an active business than the later three, where the relationship had narrowed almost entirely to Yan's clinic.
2. Gathered the documentary record of how work actually happened, not just what the contract said. We collected invoices, calendar records, correspondence about scheduling decisions, and records of the equipment the corporation had purchased and used independently of the clinic. Some of this helped the client's position; some of it, honestly, confirmed the CRA's read of the later years. We told Gurpreet and Navdeep plainly which parts of the record supported the corporation's position and which did not, so the negotiating strategy was built on an accurate picture rather than wishful thinking.
3. Filed a notice of objection within the required deadline. A notice of objection is the formal step that disputes a CRA reassessment and pauses collection on the disputed amount while the file moves to an appeals officer who was not involved in the original audit. Missing that deadline would have closed off any route to negotiate and left the reassessment standing.
4. Negotiated with the CRA's appeals division rather than proceeding straight to the Tax Court of Canada. Litigation was available if a resolution failed, but a Tax Court case over facts this fact-dependent would have taken years and cost far more than the dispute justified for either side. We made the case that the first year's facts genuinely supported active-business treatment, while acknowledging that the later years were a harder sell, and proposed a split resolution rather than an all-or-nothing outcome.
5. Restructured the consulting arrangement going forward, before signing any settlement. A negotiated result on past years means little if the same problem simply recurs next audit cycle. We worked with Gurpreet and Yan's clinic to rewrite the consulting agreement to match how the work would actually be performed if it were to continue qualifying as an active business — genuine flexibility on hours, the corporation supplying its own core equipment, and space to take on other clients rather than treating the arrangement as exclusive in practice as well as on paper.

The outcome

The appeals officer accepted the argument for the first year: the outside project and the client's own financial risk on that engagement were enough to preserve active-business treatment, and the small-business rate and expense deductions for that year stood as originally filed. For the remaining three years, the CRA held its position that the relationship had functioned as a personal services business, and additional tax and interest applied.

The final negotiated liability came to roughly $410,000 — reduced from the roughly $850,000 originally proposed, but still a significant bill covering three of the four years in dispute. The CRA agreed to a payment arrangement rather than requiring the full amount at once, which mattered given how much of the corporation's retained earnings the assessment consumed.

It was not the outcome either side would have chosen going in. The CRA gave up ground on a year it might have won outright had the matter gone to court, and Gurpreet and Navdeep paid a substantial reassessment on the years where the facts simply did not support the position the written contract described. Both sides avoided the cost, delay and uncertainty of a multi-year Tax Court proceeding over a dispute that turned almost entirely on factual detail rather than a clean legal question.

Going forward, the restructured agreement with Yan's clinic gave the arrangement a genuine chance of holding up if it is ever audited again — not because a new contract was signed, but because the corporation's actual working pattern now matches what that contract describes.

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