Introduction – Employee Remuneration or Commericial Partner?
When the provincial government of Ontario replaced the OHIP premiums with the Employer Health Tax, a burden was placed on employers in the province to remit a tax determined as percentage of the total remunerations paid to its employees within the province. Generally speaking, what constitutes 'remunerations' paid to employees is everything that would be included in the income tax return of an employee. This is specifically included in the definition of remuneration in the Employer Health Tax Act, referring to the sections of the Income Tax Act (sections 5, 6, & 7) which define the scope of that category of income.
With the Employer Health Tax Act, as with the Income Tax Act, some types of commercial relationships are not easily determined as being that of an employment relationship or that of a contractor-to-contractor. For this reason, small businesses providing any type of service, or proprietors who work primarily as subcontractors, with few clients at any given time are highly susceptible to incorrect assessment by the Ontario Ministry of Finance under the Employer Health Tax Act. Given the complexity of determining the correctness of assessment in ambiguous cases, it is imperative to the taxpayer to hire an experienced Canadian tax lawyer to advise a business being audited when facing this issue.
Comparing the Legislation
The Income Tax Act contains an anti-avoidance provision to prevent individuals employed in a business from incorporating to avoid the higher marginal rates that are applied to individuals. This is referred to in the Income Tax Act as a 'personal service business'. The characterization of a corporation as a 'personal service business' results in a much higher rate of tax being applied to its income than is otherwise applied to business income earned by corporations.
The Employer Health Tax Act in Ontario does not contain any reference to this provision of the Income Tax Act, nor does it contain a duplicate provision. Instead the Employer Health Tax Act contains a provision which characterizes payments that are made by a third party to an employee of the employer remitting the employer health tax to be 'remuneration' on account of the employment relationship and thus included in determining the total tax to be remitted by the employer. This provision is meant to bring about the same effect that would be achieved if the act contained a provision which required payments made to 'personal services businesses' to be included in determining the total remuneration paid to employees.
However, the language used in the legislation differs substantially from that of the Income Tax Act and thus deserves its own careful consideration:
Employer Health Tax Act, S.1(7)
"deemed remuneration" If all of the following circumstances exist, an amount paid to an employee of an employer by a third person after December 31, 1998 shall be deemed to be remuneration paid by the employer to the employee:
- The amount is paid to the employee for providing a service in Ontario to a person other than the employer.
- The services is substantially similar to employment functions that can reasonably be expected to be performed by an employee of the employer in the normal course of employment.
- At the time the employee provides the service, he or she is an employee of the employer.
- It is reasonable to believe that the employee would not have been engaged to provide the service if he or she was not employed by the employer.
- The employer does not pay the employee any reasonable amount of remuneration or other compensation for providing the service.
- The amount is not otherwise included in the employer's total Ontario remuneration paid for the year.
Income Tax Act, S.125(7)
"personal service business" carried on by a corporation in a taxation year means a business of providing services where
- An individual who performs services on behalf of the corporation (in this definition and paragraph 18(1)(p) referred to as an "incorporated employee"), or
- Any person related to the incorporated employee
Is a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, unless
- The corporation employs in the business throughout the year more than five full-time employees, or
- The amount paid or payable to the corporation in the year for the services is received or receivable by it from a corporation with which it was associated in the year;
As can be seen, both provisions rely on the existence of an employment relationship between the two working entities. The differences between the two provisions are in fact numerous. The provision in the income tax act requires the 'incorporated employee' to be a shareholder of the corporation being characterized while the Employer Health Tax Act does not. The Income Tax Act also provides for two exceptions to the application of this rule in paragraphs (c) & (d), which are not available in the provincial legislation. The Employer Health Tax Act provision requires that all six of the criterion are met for it to be applicable, thus in addition to the employment relationship it must also be true that (4) it is reasonable to believe the service provider would not have been engaged with but for the employment relationship, (5) no amount otherwise is paid to for the service, and (6) the amount of the payment being characterized is not already included in that employer's 'total remuneration'.
It is interesting to note that the amount to be included in 'total remuneration' is not the amount paid by the employer but rather the amount received by the employee from the third party. This would lead to the conclusion that where an individual is deemed to be an employee of the employer, and that employee is operating through an incorporated business entity (the third party), the amount to be included in the total remuneration is not the amount the incorporated business received from the employer but rather the amount the corporate entity then paid to the employee.
The Case Law
As 'employee' is not exhaustively defined in either legislative scheme, in determining the presence or absence of an employment relationship we must look to the common law for guidance. Within the context of the Income Tax Act, the leading case authority is Wiebe Door Services Ltd v M.N.R. This case laid out four factors that, when considered in concert, would determine whether a given factual relationship between commercial entities was an employment relationship or a contractor-to-contractor relationship. Those four factors are (1) the ownership of the tools employed in the work, (2) control/discretion over the methods employed in the work, (3) the chance of profit or loss for the service provider, and (4) the degree of integration of the work provided within the business.
The Employer Health Tax Act is a recently enacted legislative scheme and for that reason there is a dearth of case law to provide guidance. Where the issue has gone to the courts under this act, such as the cases SMI Sales Inc v Service Mold Inc. and IBM Canaada Ltd. v Ontario M.O.R.¸ the courts have chosen to rely on the case law principles enumerated in Wiebe and others that followed under the Income Tax Act.
The Ontario Ministry of Finance has published its own guidelines for determining where an employment relationship will be identified for payments to corporations or self-employed individuals. To quote the passage "in the case of a one-person operation where the business is incorporated and that person is the sole shareholder and works for the corporation, that person is considered to be an employee of the corporation (not self-employed) and the remuneration paid by the corporation (excluding dividends) is subject to Employer Health Tax". This is incorrect for a number of reasons but the most important one is identified in the disclaimer placed at the beginning of the publication. That disclaimer reads "this publication is provided as a guide only. It is not intended as a substitute for the Employer Health Tax Act and Regulations". No publication by any administrative body has the capacity to substitute its own rules for those set down by the legislature and courts.
Tax Tip: Save Yourself the Headache
If you find yourself facing a tax audit from the Ontario Ministry of Finance with the potential for considerable amounts of your businesses consultation fees or management fees paid to independent contractors you will be best serving your business by hiring one of our experienced Canadian tax lawyers to represent you in dealing with the tax auditors. You will need to work with your tax lawyer to ensure that they are given a complete and accurate understand of the facts involved in the work that is contracted for. Your tax counsel will be able to advocate on your behalf with an understanding of the law and the administration of it that other professionals will simply not be able to match. You will not only save yourself the tax you do not legitimately owe but also save yourself the headache of trying to explaining to tax auditors who may only be relying on Ministry guidelines in making their assessments why your relationship is that of contractor-to-contractor.