Published in Taxation of Executive Compensation and Retirement, February 2004.
The design of employee or executive secondment agreements raises taxation issues that may not be immediately apparent. Where employees are being seconded within a corporate group or between arm’s-length parties, care should be taken to ensure that the desired business results are achieved. Two tax issues in particular should be considered: whether the secondment arrangement will be subject to GST, and whether the seconding employer (the normal employer of the seconded employee) or the receiving employer (the employer temporarily receiving the employee’s services) is responsible for withholding and remitting source deductions to the Canada Revenue Agency (CRA).
In a typical secondment agreement the parties may characterize the employer-employee relationship differently for different purposes, such as
- ability to direct and control the employee;
- responsibility for compensating the employee;
- ability to terminate the employee; and,
- apportioning legal liability, including liability for severance on termination of the employee without cause.
In some cases, such as those in which there is a fixed term for the secondment, the seconding employer may wish to continue to be characterized as the employer at common law, and the receiving employer not to be considered the employer for the purpose of the secondment agreement. Typically in such an agreement, the seconding employer continues to compensate the employees, and the receiving employer reimburses the seconding employer for employment-related expenses.
This type of arrangement has the effect of separating the party that controls and directs the employee from the party that actually compensates the employee.1
Which party or parties to a secondment agreement will be considered the employer(s) depends primarily upon the purpose for that determination is made. Some statutes governing the employment relationship define which party will be considered an employer specifically for the purpose of that statute. For example, the Canada Pension Plan (CPP) defines an employer as "a person liable to pay salary, wages, or other remuneration for services performed in employment."2 The CPP definition is made for reasons of administrative convenience, but liability for compensation of an employee is also one element of the common-law test for an employee (versus an independent contractor).3
A secondment of an employee also raises the question whether the supply of the seconded employee’s services to the receiving employer constitute a "taxable supply" by the seconding employer within the meaning of section 123(1) of the Excise Tax Act (Canada) (ETA). If this is a taxable supply, the seconding employer would be required to collect GST on the payments made by the receiving employer in respect of those services.
In general, services provided by employees to the receiving employer will not constitute a taxable supply under the ETA because CRA takes the position that the party that controls and directs the employee—that is, the receiving employer—is the employer for the purposes of the ETA. For other purposes, however, it may be desirable to characterize the seconding employer as the employer. Those drafting and negotiating employee or executive secondment agreements should be aware of this issue and the analysis that the CRA is likely to apply to such agreements.
To constitute a taxable supply under subsection 123(1) of the ETA, something must first be a "supply," which consists of the "provision of property or a service in any manner" according to the definition in subsection 123(1). Since the employee’s services do not constitute property, they can only be a "supply" if they are a "service."
Under the definition of "service" in subsection 123(1) of the ETA, anything that is "supplied to an employer by a person who is ... an employee" of that employer, "in the course of or in relation to the office or employment," is not a service. Where there is no "service," there is no "supply," and no "taxable supply," and therefore those services are not subject to GST. This is the same reason why employees do not need to collect GST on regular payments of wages or salary made to them by their employers.
There is no definition of the term "employer" in the ETA. Accordingly, in determining whether an entity is an employer in a secondment arrangement, CRA will apply a form of the common-law test, discussed above. In particular, CRA considers the question of direction and control to be paramount. Therefore, in a typical secondment, CRA would determine that the receiving employer is the employer of the employee. CRA has confirmed that payments made in respect of that relationship are therefore not subject to GST, even though the employee is being paid through an intermediary (the seconding employer).4
The position taken by CRA is helpful because it permits parties to compensate employees through the seconding employer without incurring a GST cost.
Employees, of course, have different rights and obligations from independent contractors, including treatment under the ETA: independent contractors’ services would fall within the definition of "service" under the ETA and would therefore be potentially subject to GST. The test for an employee (versus an independent contractor) has evolved in Canada from the traditional "control test."5 This test was expanded, most recently in Wiebe Door Services Ltd. v. Canada (Minister of National Revenue), to the "fourfold test."6 The fourfold test examined the elements of the control test and other factors, including ownership of tools, chance of profit and risk of loss.
Finally, the "organization" or "integration test" was articulated in Stevenson, Jordan and Harrison Ltd. v. MacDonald,7 and expressed in Canada in 671122 Ontario Ltd. v. Sagaz Industries Canada Inc.,8 although this case has been subject to considerable commentary. This test asks whether the services rendered by the individual are normal business requirements, or adjunct or unusual services.
It should be noted, however, that the CRA’s position set out above does not mean that the receiving employer will necessarily be considered the employer for other purposes—for example, statutory deductions and withholdings and/or the common-law test.9 In general, no matter which party (seconding employer or receiving employer) is to be treated as the employer for other purposes, a short provision indicating that the seconded party is to have direction and control of the employee, and that therefore the employee’s services do not constitute a "service" within the meaning of the ETA (if this is consistent with the parties’ business objectives), will be helpful to avoid the imposition of GST.
Statutory Deductions and Withholdings
The question whether the seconding employer or the receiving employer will be responsible for deductions and remittances under Part I of the Regulations to the Income Tax Act10 (ITA) must be considered separately from the GST analysis. In particular, the responsibility for source deductions is complicated by paragraph 102(1)(a) of the Regulations, which states that employers are responsible for source withholdings on payments of "remuneration" (as defined in Regulation 100(1)) to employees who "[report] to work at an establishment of the employer in a province, in Canada beyond the limits of any province or outside Canada."
Furthermore, Regulation 100(4) provides that where an employee is not required to report for work at any establishment of the employer, he or she shall be deemed to report for work (in respect of salary, wages or commissions) at the establishment of the employer who pays the remuneration.11 This is relevant in a secondment situation because where a seconding employer continues to pay an employee, the employee may be deemed to report at the seconding employer’s establishment.
Unlike in the ETA, "employer" is defined for the purposes of Part I of the Regulations, in Regulation 100(1), as "any person paying remuneration." "Remuneration," for its part, is also defined in Regulation 100(1) and includes payments in respect of salary or wages. Therefore, the party who pays the salary or wages to the employee, whether that person is the seconding employer or the receiving employer, will be considered to be the employer for source deduction purposes. This employer will frequently be distinct from the employer for ETA purposes, for the common-law test, or even for CPP purposes.12
A CRA Views Document dated July 21, 1992 (No. 9214537 - Place of Employment for 24(1)) contains an analysis of a secondment scenario in which an employer has seconded an employee to a joint venture that the seconding employer is part of. The document reminds the questioner that a joint venture or partnership is not a "person" (and so cannot be an "employer" for the purposes of Part I of the Regulations) and goes on to say the following:
Source Deductions Division provided us with a legal opinion which suggests that where remuneration is paid through an agent, both the agent and the employer are liable for source deductions required to be withheld and remitted to the Receiver General for Canada; however, the employer is the person who directs the employee in the duties of employment and who is liable for the remuneration.
This letter has a different conclusion from the plain language of the ITA. It makes sense that where a mere agent pays the employee, the principal is ultimately the payor (and therefore the "employer" under Regulation 100(1)). The second clause indicates that elements of the common-law test will be applied in determining the "employer." This does not seem to be the correct legal result. Instead the clear language of the definition in the statute should govern. While it is relevant for the common-law definition of employer, the question of who directs the employee does matter for the purposes of determining the employer; however, for Part I of the Regulations this should not be so. It appears that Source Deductions Division has become confused with regard to which definition of "employer" is to apply in this situation.
A brief provision in a secondment agreement that explicitly states which party is responsible for source withholdings and remittances (responsibility for which should be assigned to the party actually paying the employee’s salary) can potentially save trouble with CRA or with a co-contractor over these issues.
On balance, due to the potentially troublesome tax issues involved in a secondment agreement, it should specify the factual matters relevant to the determinations and which party is responsible for payments. Unintended consequences can be avoided when control, payment and responsibility are properly allocated.
1. This scenario also creates ambiguity in the characterization of the employer at common law. An analysis of this issue is beyond the scope of this memorandum, and should be examined on a case-by-case basis considering all the relevant elements of the control test (see e.g. Hôpital Notre-Dame de l’Espérance and Théoret v. Laurent,  1 S.C.R. 605 [Hôpital Notre-Dame de l’Espérance]); fourfold test (see Montreal v. Montreal Locomotive Workers Ltd.,  1 D.L.R. 161 (P.C.) [Montreal Locomotive Workers] and more recently Wiebe Door Services Ltd. v. Canada (Minister of National Revenue),  3 F.C. 553 (F.C.A.) Wiebe Door Services]); or organization test Also note the status of "intermediate worker" identified in Carter v. Bell & Sons,  O.R. 290 (C.A.) and affirmed in Job v. Remax Metro-City Realty Ltd.,  O.J. No. 5029 (C.A.).
2. R.S.C. 1985, c. C-8, s. 2(1).
3. In the case of employees, it is administratively convenient to make CPP deductions at source.
4. This reasoning was recently confirmed in discussion with CRA’s GST Rulings Directorate.
5. See e.g. Hôpital Notre-Dame de l’Espérance, supra note 1.
6. See Montreal Locomotive Workers Ltd., and Wiebe Door Services Ltd., supra note 1.
7.  1 T.L.R. 101 (C.A.).
8.  S.C.J. No. 61.
9. It is possible, therefore, for the seconding employer to be considered the employer for the purposes of a statute requiring deductions or withholdings, and not to be considered an employer for the purposes of the ETA.
10. R.S.C. 1985, c. 1 (5th Supplement (as amended).
11. In respect of other kinds of remuneration, such employees are deemed to report for work in the province in which the employee resides. Where an employee is seconded to another province, this can give rise to different treatments (in different provinces) for withholding purposes, for different types of remuneration.
12. For CPP purposes, the person who is "liable to pay" the salary or wages is the employer, as distinct from the person who actually pays.
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.