As an employment lawyer, I am often approached by clients on the issue of "independent contractors versus employees". Corporate clients look to use independent contractors, rather than employees, to perform work more cheaply and with more flexibility – without costs such as CPP, EI, EHT, WSIB premiums, benefits, overtime, etc. and without the necessity of complying with employer obligations such as those found under the applicable employment standards legislation. Individual clients want to provide "consulting" or "contractor" services to third parties with the associated tax savings afforded to true independent contractors.
In either case, I provide the following words of general advice.
- I first tell clients that it is simply not enough to call an individual an independent contractor for that individual to actually be a true independent contractor at law. Whether an individual is most likely a true independent contractor or an employee will depend on the specific facts in each case. To assist with such assessment, I provide clients with a checklist of approximately 40 different factors to consider, representing those factors most often considered by our courts, tribunals and governmental bodies.
- Next, I tell clients that there are serious consequences if an individual is treated as being an independent contractor when he/she is legally an employee -- so it is important to "get it right!" For instance:
(a) Income Taxes:
If an individual is found to be an employee under the Income Tax Act, the individual will be responsible for paying all resulting back taxes, and many of his/her expenses may be disallowed. Interest and penalties will also ensue. The entity found to be the employer could also be penalized for failing to properly withhold income tax. Liability is up to the amount that the employer should have withheld from fees or wages, plus a 10% penalty, which increases to 20% on a second violation.
While the CRA has the right to collect the amounts owing from either or both of the individual and the employer, the CRA would usually seek payment first from the individual (who has had the benefit of the funds, after all), pursuing the employer only if the individual is unable or unwilling to pay, i.e. when the individual cannot be located or is bankrupt. Penalties may still be imposed on the employer, however, regardless of collection of the taxes from the individual.
Directors have joint and several liability for remitting tax payments to CRA, including interest and penalties, if payment cannot be obtained from the employer. There are also penalties available upon prosecution, including fines up to $25,000.00 and up to 12 months' imprisonment.
(b) Employment Insurance
If an individual is found to be an employee under the Employment Insurance Act, the entity found to be the employer will be liable for both its contributions and the deductions that it ought to have taken from the individual, as well as a 10% penalty on these amounts, increasing to 20% for a second offence, plus interest.
Directors are jointly and severally liable with the employer for these amounts. Prosecution, with penalties including fines up to $5,000, imprisonment for up to 6 months, or both, is also contemplated by the Employment Insurance Act.
(c) Canada Pension Plan
If an individual is found to be an employee under the Canada Pension Plan Act, the entity found to be the employer will be liable for both its contributions and the deductions that it ought to have taken from the individual, as well as the aforesaid 10% or 20% penalty and interest.
Directors are liable for premiums, penalties and interest, but only where the employer fails to pay. Failure to deduct and remit CPP premiums is also an offence punishable by a fine of up to $5,000, imprisonment for up to 6 months, or both.
(d) Employment Standards
Employment standards legislation differs from province to province; however, in most provinces, the applicable employment standards legislation would govern such things as hours of work, overtime, minimum wages, public holidays, vacations with pay, various kinds of leaves, and notice of termination (or pay in lieu). True independent contractors do not
have the benefit of the protections set out in the applicable employment standards legislation.
However, if an individual is found to be an employee at law and has not received his/her entitlements to such things as overtime pay, minimum wages, public holidays, vacations with pay, termination notice/pay, etc., the entity found to be the employer will be liable for these amounts. In such case, the individual will have the benefit under the applicable employment standards legislation to a variety of remedies for breach of this legislation, which often includes such things as back pay, compensation and reinstatement. Most employment standards legislation also provides for such things as penalties, charges, prosecutions, director liability, etc.
The entity found to be the employer could also be required to pay EHT, workers compensation premiums, etc. that it didn't previously pay in respect of, and/or withhold and remit on behalf of, these individuals (subject to the specific limitation periods in the governing legislation). There is also the risk of fines, penalties, interest, charges, etc. under most such legislation.
Another concern is that the entity found to be the employer may not be able to claim any HST input tax credits on the HST payments already made to these individuals.
A further concern relates to termination obligations. True independent contractor relationships can be terminated, by either party, on relatively short notice, unless the parties have agreed otherwise. In contrast, employees are entitled to common law reasonable notice of the termination of their employment, which can be fairly substantial depending upon the situation – unless, of course, the parties have taken proper and legally enforceable steps to "contract out" of those common law entitlements.
- Third, I tell clients who, after reviewing the checklist and the above risks, nonetheless want to enter into an independent contractor relationship that they should structure the relationship in such a way that: (a) as many as possible of the independent contractor factors exist; and (b) as few as possible of the employee factors exist -- AND to follow that structure during the term of the relationship. While courts/tribunals/governing bodies will certainly look at, and consider, what is set out in writing between the parties, they are really interested in what actually transpires during the relationship.
- Finally, from a practical perspective, I always strongly recommend to clients that they ensure that the relationship is clearly set out in an appropriately drafted Independent Contractor Agreement. Such agreement should, in my view, highlight factors supportive of an independent contractor relationship and downplay any factors suggesting an employment relationship. Further, when representing corporate clients (which is most often the case for me), such agreement should also, in my view, include: (a) legally enforceable termination provisions, including a provision that limits the individual's entitlement upon termination (if ever found to be an employee at law) to the minimums under applicable employment standards legislation; and (b) a clear indemnity provision, whereby the individual agrees to indemnify the corporate client for (among other things) any costs, damages, awards, legal fees, fines, penalties, etc. resulting from any allegation and/or finding that the individual is an employee at law.
While this is all sound advice, it will be even more important to some if certain proposed changes are made to the Income Tax Act. On October 31, 2011, the Department of Finance proposed changes that would effectively end the advantageous tax planning strategy of having individuals (who would otherwise be considered to be employees) provide their services through a corporate entity (a "Personal Services Business") and would, in fact, potentially create a significant tax cost to such individuals. Because true independent contractors providing their services through a corporation will not be affected by these proposed changes, I fully expect that many individuals currently with Personal Service Businesses will want to restructure their relationships to resemble that of true independent contractors, whenever possible, to avoid the negative consequences of these proposed changes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.