Does a 40-Hour Contract Make You an Incorporated Employee?

No. A 40-hour contract does not by itself make you an incorporated employee. Fixed hours are one control fact among many. Under section 125(7), CRA asks whether you would reasonably be the client’s employee if your Ontario corporation did not exist. If so, its income is usually PSB income, taxed at 44.5% instead of 11.2%.

Key takeaways

Why do so many contractors ask this question?

Many contractors I work with have a contract that says 40 hours a week. Some say 37.5 or 35. They bill through their own Ontario corporation, often through a staffing agency, to a bank, an insurer, a government or a large enterprise.

Sooner or later, someone tells them that a 40-hour week makes them an “incorporated employee”, and that CRA will tax their corporation as a personal services business (PSB).

That is half right. The term is real. It comes straight from the Income Tax Act. But the hours do not decide it. To see why, it helps to know what the term actually means.

What is an incorporated employee under section 125(7)?

Section 125(7) defines a personal services business. Inside that definition is the term “incorporated employee”. It means the individual who performs the services on behalf of the corporation. For most contractor corporations, that person is you.

In everyday use, people say “incorporated employee” for someone who fails the PSB test: a person who would be the client’s employee if the corporation were taken away. That is the sense of the question in the title.

Your corporation carries on a PSB in a year when two links are present, unless an exception applies. If either link is missing, the corporation is not a PSB.

The specified shareholder link

The first link is ownership. You, or a person related to you, must be a specified shareholder of the corporation. That means owning 10% or more of any class of shares, directly or indirectly.

A person related to you includes your spouse. So putting the shares in your spouse’s name does not break this link.

For almost every one-person contractor corporation, this link is present. You own the shares, and you do the work.

The “if the corporation did not exist” question

The second link is the one that matters. Would you reasonably be regarded as an officer or employee of the person receiving your services if your corporation did not exist?

This is a thought experiment. Take the corporation out of the picture. Look at the working relationship that is left. If it looks like employment, you are an incorporated employee in that everyday sense, and the corporation’s income from those services is PSB income unless an exception applies.

To answer it, CRA uses the tests the courts set out in Wiebe Door Services Ltd. v. M.N.R. and 671122 Ontario Ltd. v. Sagaz Industries Canada Inc. The central question is whose business it is. The main factors are:

• Control: who directs the work, and how it is done.
• Tools: who owns the equipment you use.
• Chance of profit and risk of loss.
• Integration, meaning whether your work is part of the client’s business or part of your own business.

Hiring helpers, your own investment and how you manage the work also count. A contract that calls you an “independent contractor” does not settle it. What happens day to day counts more than the label. I explain the full set of rules, including what happens to deductions, on our page about personal services business risk.

Where do 40 hours fit in the incorporated employee test?

Hours sit under control. A 40-hour week tells me how much time the client is buying. It does not tell me who is in charge of the work.

What I look at is what sits around the hours:

• Are the 40 hours a billing cap, or a required schedule with set start and finish times?
• Does an end client manager approve your timesheet and your time off, the way they would for staff?
• Must you work onsite, or only through the client’s VPN, on a client-supplied laptop?
• Does the client need to approve any extra hours?

Each “yes” adds weight to control. None of them answers the question alone. A 40-hour week with a clear statement of work, your own tools and real financial risk can still look like a business. A 35-hour week inside an open-ended role, managed like staff, can look like employment.

Many of these rules, like VPN-only access and client laptops, exist for security at banks, insurers and governments. They often apply to every outside firm. I still treat them as control indicators, but I note the reason.

The test also runs year by year. Each taxation year of your corporation is judged on its own facts. A renewal that moves you onsite full-time, or a new manager who assigns your daily tasks, can change the answer for that year.

I go through each hours clause, and what to document for it, on our page about 40 hour contract PSB risk. I compare 35, 37.5 and 40 hour terms in a separate post on contract hours and the control test.

Who is the “client” when you work through an agency?

Most of my IT and finance contractors work in a three-party setup: your corporation, a staffing agency and the end client. The agency signs your contract and pays your invoices. The end client manages the work.

In this setup, CRA looks at whether you would reasonably be an employee of the party your services are really provided to. That is usually the end client. So the agency contract matters, but so do the end client’s onboarding rules, its security rules and the way its managers treat you day to day.

A clean agency contract does not help much if the end client runs you like staff. And a strict security policy at a bank does not, on its own, make you staff.

How does an employee-style 40-hour engagement compare with a business-style one?

Here are two engagements with the same 40-hour week. The hours are identical. The rest is not.

The left column points toward an incorporated employee. The right column gives you facts that can support your position. Neither column promises a result. Real files sit somewhere in between, and the same contract can move left or right from one year to the next.

What does it cost if you are treated as an incorporated employee?

Let me put numbers on it. Take a contractor billing $95 an hour, 40 hours a week, for 48 weeks.

$95 x 40 x 48 = $182,400 of billings.

Assume the corporation spends $9,000 on equipment, software, insurance and accounting. It pays no salary and keeps the income. Assume a full taxation year at the current 11.2% combined Ontario small business rate.

Same billings, two results

• Not a PSB: ($182,400 – $9,000) = $173,400 x 11.2% = $19,420.80 of corporate tax.
• PSB: the $9,000 of expenses is denied under section 18(1)(p), so $182,400 x 44.5% = $81,168 of corporate tax.
• Extra tax: $81,168 – $19,420.80 = $61,747.20 for one year.

Why is the gap so large? A PSB loses most of its deductions, the small business deduction and the 13% federal general rate reduction. It also pays the additional 5% federal tax under section 123.5. That makes 33% federal plus the 11.5% Ontario general rate, or 44.5% in total.

A note on the rate. The 11.2% applies to income earned from July 1, 2026. Income earned before that date was taxed at 12.2%. If your corporation’s year ends December 31, 2026, the blended rate is 11.70%. On the same $173,400, that works out to $20,280.67 using the exact day count.

What changes if you pay yourself a salary?

Section 18(1)(p) still allows salary and other pay to the incorporated employee. So pay planning matters. Say the corporation pays you a salary of $120,000:

• Not a PSB: ($182,400 – $9,000 – $120,000) = $53,400 x 11.2% = $5,980.80.
• PSB: ($182,400 – $120,000) = $62,400 x 44.5% = $27,768.
• Extra tax: $21,787.20.

This leaves out employer CPP and does not show personal tax on the salary. Salary narrows the corporate gap. It does not close it.

Does paying a dividend fix it?

Not fully. PSB income is not eligible for the small business deduction, so it is taxed at the full rate and adds to the general rate income pool (GRIP). Dividends paid from it can be designated eligible dividends. Integration still leaves a gap.

Take $100,000 of PSB income at top 2026 Ontario rates. Corporate tax is $44,500. The eligible dividend of $55,500 is taxed at 39.34%, or $21,833.70. Total tax is $66,333.70. The same $100,000 paid as salary at 53.53% costs $53,530. The PSB route costs $12,803.70 more.

Are there exceptions to the incorporated employee rule?

There are two. First, the corporation employs in the business, throughout the year, more than five full-time employees. That means at least six, full-time, all year. Whether owners or family members count depends on their real roles, so it needs review.

Second, the amount for the services is received from a corporation associated with yours in the year.

Most one-person contractor corporations that bill a staffing agency fit neither exception. So the “if the corporation did not exist” question is usually where the file is decided.

What can you do this year?

You cannot change the test. You can make sure the real facts are clear and on file. Each year, I suggest keeping:

• Your share register, so the ownership link is on record.
• Your agency contract and statement of work, with each extension or renewal.
• The end client’s onboarding, security and equipment rules, with a note on which ones apply to every vendor.
• A short note on why your hours are fixed, such as a budget cap or a release date.
• Invoices that name deliverables as well as hours.
• Receipts for the equipment, software, training and insurance your corporation pays for, and proof of any other clients.

We review your contract and working facts as part of tax planning. We read the agency contract, the statement of work and the onboarding rules. We ask how the work happens day to day. We map those facts against control, tools, profit and loss, and integration. Then we look at your pay mix, because salary stays deductible even in a PSB. You can see how clauses are read on our PSB contract review page, and in my post on contract clauses that raise PSB risk.

CRA’s guide RC4110, “Employee or Self-Employed?”, sets out how CRA looks at a working relationship. Form CPT1 is used to request a CPP and EI ruling on a worker’s status. A CPT1 ruling deals with CPP and EI. It is not a PSB ruling for income tax, though CRA looks at similar facts. We review whether it is useful in your facts.

We are accountants, not lawyers. If a clause needs new wording, that is for your lawyer.

If your contract says 40 hours and you want to know how your facts read, please book a consultation. Please have your agency contract, statement of work and onboarding package with you. You can also call us at 647-212-9559, 9AM to 8:30PM, Monday to Sunday.

Frequently asked questions

What is an incorporated employee?

It is the term section 125(7) uses for the individual who performs services on behalf of a corporation. If that person would reasonably be regarded as the client’s employee without the corporation, and is a specified shareholder or related to one, the corporation carries on a PSB unless an exception applies.

Does working 40 hours a week make me an incorporated employee?

Not by itself. Fixed hours are a control fact. CRA weighs control together with tools, chance of profit and risk of loss, and integration, and asks whose business it is.

If my spouse owns the shares, can I still be an incorporated employee?

Yes. The ownership link is met when you or a person related to you, such as your spouse, owns 10% or more of any class of shares, directly or indirectly.

When I work through an agency, who is the client for the test?

CRA looks at whether you would reasonably be an employee of the party your services are really provided to. That is usually the end client, so its onboarding rules and day-to-day management matter as much as the agency contract.

How much more tax would a PSB pay on a 40 hour contract?

The combined PSB rate is 44.5%, compared with the 11.2% small business rate from July 1, 2026. On $182,400 of billings with $9,000 of expenses and no salary, the extra corporate tax is $61,747.20 for one year.

Can my corporation still deduct my salary if it is a PSB?

Yes. Section 18(1)(p) allows salary and other pay to the incorporated employee, plus a few other items. Most other costs, such as rent, software, equipment, travel, phone, insurance and accounting fees, are denied.

Is the incorporated employee question decided once for the whole contract?

No. Each taxation year of your corporation is tested on its own facts. A renewal, a new manager or a move to full-time onsite work can change the answer for that year.