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At the start of a business relationship a worker and payer often think it is a very good idea to set up their relationship as an independent contractor entering into a contract with the paying business.
At the start of a business relationship a worker and payer often
think it is a very good idea to set up their relationship as an
independent contractor entering into a contract with the paying
business. This permits the paying business the advantage of not
having to make source deductions of Employment Insurance
"EI", CPP, and income taxes nor pay health tax and
workplace safety insurance premiums. The worker benefits in that
he/she can deduct all reasonable business expenses from income.
Sounds good but is it?
Why Does It Matter?
There are a couple of reasons:
The Canada Revenue Agency ("CRA") may audit the
paying business and determine that the relationship is not one
involving an independent contractor but rather is in reality an
employer/employee relationship. The CRA will then demand that the
employer remit past unremitted EI and CPP and charge penalties and
interest. The corporate employer's directors may be held
personally liable. The employee may be required to review past
income tax returns to limit past business expenses claimed.
On a breakdown of the relationship, if the independent
contractor can establish that he/she is in reality an employee,
he/she may be entitled to termination pay under the Employment
Standards Act ("ESA") or under common law.
Advantages
Disadvantages
Employee
qualify for employment insurance
CPP premiums – 50% paid by employer
participation in employee benefits:
vacation pay
extended heath benefits
disability insurance
pension plans
workplace safety insurance premiums paid
higher rate of pay for overtime hours
more difficult to be terminated
termination/severance pay if terminated
no record keeping required
must pay employment insurance premiums
very few expenses are tax-deductible
less control over working conditions and hours
must pay employment insurance premiums
very few expenses are tax-deductible
less control over working conditions and hours
Self-Employment
no employment insurance premiums
more expenses are tax-deductible
more freedom to choose own working hours
can work for more than one business
opportunity for increased profits
can recover HST paid
no termination/severance pay if terminated
cannot collect employment insurance
must pay employee and employer portions of CPP
must pay workplace safety insurance premiums
record-keeping required
often work longer hours with no extra pay
cost of purchasing and maintaining own equipment
risk of loss
insurance coverage costs
liable if contract obligations not fulfilled
no employee benefits
income tax instalment payments required
may be required to register for HST
cash management and planning required to ensure funds available
for tax remittances
may require services of a bookkeeper or accountant for the
record keeping and government reporting
no termination/severance pay if terminated
cannot collect employment insurance
must pay employee and employer portions of CPP
must pay workplace safety insurance premiums
record-keeping required
often work longer hours with no extra pay
cost of purchasing and maintaining own equipment
risk of loss
insurance coverage costs
liable if contract obligations not fulfilled
no employee benefits
income tax instalment payments required
may be required to register for HST
cash management and planning required to ensure funds available
for tax remittances
may require services of a bookkeeper or accountant for the
record keeping and government reporting
How to tell?
Through various court actions the case law (common law) has
developed a test to determine whether a person is an employee or a
self-employed individual. The CRA uses the common law test in its
determination of the issue. For jurisdictions, other than Quebec,
the test has developed into a two-step test:
Determine the subjective intent of the parties. How do the
parties define their relationship and do they both have the same
understanding? Was there a written contract between the parties or
can intent be determined by their actual behaviour? Were invoices
rendered for the services, did the worker register for HST
purposes, and did the worker file income tax returns as an
independent contractor?
Step 2 requires an objective look by looking at certain factors
to determine whether a worker is in business on his own account.
There are 6 general factors to consider as follows:
Factor
Independent Contractor
Employee
1.
Control
Level of control payer has over
worker's activities
(control is the ability, authority, or right of a payer to
exercise control over a worker concerning the manner in which the
work is done and what work will be done.)
works independently within a define framework
does not have anyone overseeing his/her activities
works without detailed directions on procedure
uses own experience, expertise to do job
sets own hours
paid on per-job basis in a lump sum
may own or control work site
usually free to work when and for whom he/she chooses and may
provide his/her services to different payers at the same time
markets services to anyone who wants them
can accept or refuse work from the payer
reports only as agreed upon
relationship does not present a degree of continuity, loyalty,
security, subordination, or integration
follows instructions on how to work
receives direct instructions regarding results of the work and
the method used to do the work
payer determines and controls the method, timing, and amount of
pay
works under set hours
works for one payer at a time
has work-related expenses paid by employer
payer has priority over the worker's time
payer determines what jobs the worker will do
payer provides training or direction on how to do the work
payer will listen to worker's suggestions but has the final
word
2.
Ownership of Tools & Equipment
worker provides the tools and equipment needed for the
work
worker is responsible for repair, maintenance, and insurance
costs
worker has made a significant investment in the tools and
equipment and the worker retains the right over the use of these
assets
worker supplies his or her own workspace, is responsible for
the costs to maintain it, and performs substantial work from that
site
payer supplies most of the tools and equipment the worker
needs
payer is responsible for repair, maintenance, and insurance
costs
worker supplies tools and equipment and the payer reimburses
the worker for their use
payer retains the right of use over the tools and equipment
provided to the worker
3.
Hires or Subcontracts
worker does not have to perform the services personally
worker can hire another party to either complete the work or
help complete the work and pays the costs for doing so
payer has no say in whom the worker hires
worker cannot hire helpers or assistants
worker does not have ability to hire and send replacements
worker has to perform the services personally
4.
Financial Risk
worker can incur profit or a loss because they pay fixed
monthly costs even if work is not currently being performed
worker responsible to pay his/her hired helpers
worker performs a substantial amount of work from his/her own
workspace and incurs expenses relating to operation of that
workspace
worker is hired for a specific job rather than an ongoing
relationship
worker is financially liable if he/she does not fulfill the
obligations of the contract
worker does not receive any protection or benefits from the
payer
worker advertises and actively markets his/her services
worker has no financial risk as his/her expenses will be
reimbursed
worker has no fixed ongoing costs; no operating expenses
working relationship is continuous
worker is not financially liable if he/she does not fulfil the
obligations of the contract
payer determines and controls the method and amount of pay
5.
Responsibility for Investment and
Management
worker has capital investment
worker manages his/her staff
worker hires and pay individuals to help perform the work
worker has established a business presence
worker has no capital investment in the business
worker does not have a business presence
6.
Opportunity for Profit
worker has a chance of profit or risk of loss because he/she
has the ability to pursue and accept contracts as he/she sees
fit
worker incurs expenses to carry out the terms and conditions of
his/her contract and to manage those expenses to maximize net
earnings
worker can hire a substitute and the worker pays the
substitute
worker is compensated by a flat fee and incurs expenses in
performing the services
worker is not in a position to realize a business profit or
loss
worker is entitled to benefit plans that are normally offered
only to employees
If you are unsure whether your business relationship is really
an employer/employee relationship or that of a payer and
independent contractor, it is best to consider requesting a ruling
from the CRA or seek the advice of a lawyer. If the CRA disagrees
with a payer's characterization of the relationship, this
may be a costly error that leads to a payroll audit, back payments,
penalties, and interest. For workers, while it may appear you are
gaining tax advantages as an independent contractor, if you are not
truly operating a business on your own account, you may be giving
up the protection of employment legislation and common law rights
upon termination of your business relationship.
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.