On October 1, 2020, Ontario’s real estate professionals officially gained the ability to incorporate by setting up their own Personal Real Estate Corporation (PREC). In practice, this means real estate agents can now start earning their commission income through their PREC.
Primary among these benefits is the ability to defer taxes by earning income inside a PREC, which is taxed at a lower rate than personal income.
However, to access this tax deferral benefit, you need to be considered an independent contractor rather than an employee of your brokerage. This may not be as straightforward as it sounds depending on the activities you carry out as a real estate professional.
Is your PREC a personal services business?
On the surface it would seem that as soon as you set up a PREC, you stop being an employee of your brokerage. After all, your company will now be earning your commissions rather than you personally. However, one of the requirements for a PREC to be exempt from registration is that you as the realtor must be employed by the brokerage to trade in real estate. To be employed by a brokerage under the “Real Estate and Business Brokers Act, 2002” includes individuals as regular employees as well as those acting as independent contractors.
The distinction between “employee” and “independent contractor” is an important one with reference to the taxation of personal service businesses (“PSB”). Generally, a PSB carried on by a corporation means a business of providing services where:
- an individual who performs the services on behalf of the corporation (referred to as the incorporated employee), or a person related to the incorporated employee, is a specified shareholder of the corporation; and
- if not for the existence of the corporation, the incorporated employee would reasonably be regarded as an officer or employee of the entity to which the services are provided, unless the corporation employs in the business throughout the year more than 5 full time employees or the amount paid to the corporation in the year for services is from an associated corporation
In basic terms, this means if you’re considered an employee of your brokerage and your PREC earns commissions from the brokerage and your PREC doesn’t employ more than five full time employees, the PSB rules could apply. As previously mentioned, the PSB rules do not apply to independent contractors so it is of utmost importance that you have an independent contractor relationship with the brokerage that employs you.
The Canada Revenue Agency (“CRA”) relies on established principles of case law in the determination of whether an individual is considered an “independent contractor” as opposed to an “employee.” Although beyond the scope of this publication, generally the CRA’s interpretation is summarized below:
- Control test – Under this test, the degree of control an employer has over an employee with reference to specific activities is greater than it is in an independent contractor relationship.
- Integration test – Determines if the contract for service is an integral part of the business (“employer-employee relationship”) versus a contract for service that is only accessory to the business.
- Economic Realty Test – This test assesses the economic aspects of the relationship between the parties to determine whether the taxpayer is carrying on business independently or working for someone else.
- Specified Results Test – This test acknowledges that in an independent contractor relationship specific tasks are carried out and ultimately ceased versus in an employer-employee relationship the employee makes himself or herself available to the employer to be used by the employer without reference to a specific result.
Getting it right
If your PREC is considered a PSB, the primary disadvantage is that you’ll lose the tax deferral associated with incorporation. That is, as a PSB, your PREC won’t qualify for the 12.2 percent small business tax rate and instead be subject to corporate tax at a rate of 44.5 percent.
- Salary, wages or other remuneration of the incorporated employee
- Cost of other benefits or allowances provided to the incorporated employee
- Certain expenses of the corporation associated with selling property or negotiating contracts
- Legal expenses paid in collecting amounts owed for services rendered
To avoid these outcomes, you need to make sure you’re considered an independent contractor rather than an employee when setting up your PREC. Want to know how? Contact your Grant Thornton advisor to learn more.
 Generally, a specified shareholder of a corporation is a person who owns alone or together with related persons 25% or more of the votes and fair market value of a corporation.
 As defined in subsection256(1) of the Income Tax Act