Employee vs Contractor – Which one are you ? Avoid reclassification and tax penalties by Canada Revenue Agency
Employers love to hire independent contractors rather than employees because of the short-term commitment to the individual; no requirement to withhold income tax and savings on EI, CPP and benefit packages; fewer legal responsibilities towards independent contractors as they would with employees. The significant tax advantage for the independent contractor is the potential for tax deductions. Usually, a self-employed person can deduct most reasonable business expenses. The contractual relationship makes it a win-win situation for both the organization and the independent contractor.
If you assume, you’re a contractor, and the Canada Revenue Agency (CRA) decides that you’re not, the organization hiring you could be liable for both the employer’s and the employee’s share of CPP and EI and withholding taxes. Moreover, your employer will be subject to the levy of penalties and interest the under-remittance of those payments. This also will lead to your income being assessed as employment income instead of business income, leading to non-availability of business deductions.
Individual contractors need to be aware of the income tax implications of these long-term contract arrangements, especially in cases where they are offering their services to just one hirer.
Due to the significance of these implications and the ambiguity of status between employees and independent contractors, this issue leads to frequent reassessments by the CRA and litigation before the Tax Court of Canada. The rules which use a four-fold test to determine if you have an employer-employee-like relationship or a business relationship have been in place for decades, those tests are:
Control test
This test is the most frequently used test. The dominant issue here is who’s running the ship. If the organization has the right to determine the time, place and way in which the work should be done, then an employer-employee relationship exists. If the employer indirectly controls the worker’s activities, as he has the right to do so, control still exists. In order to prove independent contractor status, it’s vital that you maintain the right to decide, when, where and how the work will be done.
If you can demonstrate that you are the person responsible for planning the work to be done, deciding the hours of work, and setting the standards to be met, you’ll have a higher likelihood of being deemed a contractor rather than an employee.
If the worker is a professional or skilled tradesperson who has been hired for his or her knowledge or expertise, it may be problematic to determine whether the individual or the organization has control. For this individual, the control test may be inconclusive because it will typically not be necessary to tell a professional or skilled tradesperson how to do his or her job.
Ownership of tools Test
This test addresses who supplies the tools necessary to do the work. As a worker, if you provide your own devices, this would weigh more in favor of an independent contractor relationship especially if the cost of the tools is significant in value as the CRA’s view is that the price of physical tools supplied by the individual is a better indicator of the relationship. For example, if you are a home-based IT worker – if you are using your own desktop/laptop computer, mobile devices, etc. this will suggest that you are a self-employed contractor. If the vital tool required to do the work is your knowledge or expertise, the results of this test will be inconclusive, as only you can own your experience or expertise.
Chance of profit/loss Test
Your financial involvement is an essential driver in determining whether you’re involved in an employer-employee relationship or a business relationship. In an employer/employee relationship, as an employee, you usually receive a set wage and can increase your income by working overtime. As an independent contractor, you should be able to increase profit by either working harder or more efficiently. Besides, as an independent contractor, you should be able to assume the risk of incurring losses as a result of bad debts, damage to equipment or materials, and delays. Also, as an independent contractor, you will cover your operating costs.
Integration Test
This test is looked at from your point of view, and it addresses how dependent you are on the organization. There are two aspects to this test: what proportion of your income is derived from the organization, and whether you are free to work for other entities. If the work you’re doing for a client is an integral part of the business, you may be an employee. If the work you’re doing is less integrated with clients’ businesses, you may be self-employed. One way of “proving” integration to your own commercial activities is to have multiple clients. To bolster your independent contractor status, you should also consider advertising your business in online directories; get printed brochures; consider getting a different telephone line for your business, get business cards published and distribute them; get a website and send invoices to the hirer and consider charging GST for your services.
If as a contractor, you only have one client, this point falls in favor of an employee status. Moreover, having a single client puts your small business (if you have less than five full-time employees throughout the year) in danger of being declared a personal services business by the CRA, which will result in significant adverse tax consequences.
Additional Considerations:
Intent
The CRA will also consider your intent and payer’s intent. The CRA will ask whether the two parties intended to enter into a contract of service (employer-employee relationship) or whether they intended to enter into a contract for services (business relationship).
Merely stating the intention was to agree to services will not override the results of the tests discussed above.
In other words, if the results of the criteria above are conclusive concerning the relationship, the stated intent of the worker and payer will not be a relevant factor.
Specific results
An employee is generally hired on an ongoing basis, not for one particular project. An independent contractor is usually utilized for a particular job with no guarantee of continuing work.
Recent Case Law
Homegrown Manitoban delivery service company, Skip the Dishes which operates an Uber-style online service that connects people to local restaurants and food couriers by facilitating food delivery through its website and mobile apps, has been dragged to court on this issue in a class action suit. The company claims that delivery drivers are independent contractors, whereas the workers claim they are employees entitled to protection under the employment standard laws as the company does not fairly compensate its drivers and indulges in misleading the workers by telling them they are private contractors instead of employees.
In judging whether an individual is an employee or an independent contractor, each test is examined using the case facts, and an overall conclusion is reached based on the balance of the evidence.
In some cases such as for real estate agents, the CRA has a clear administrative policy. You will be considered self-employed if you are entitled to full amount of commissions, and either
a) you pay only a fixed amount to your broker for administrative operating costs, or
b) you pay a percentage of your gross commissions to your broker to cover such costs, and you set your own commission rate for sales of your listing
The CRA has a questionnaire, From CPT-1, through which your employer /client can supply the details of its relationship with you and ask for a ruling as to whether you are an employee or not for CPP purposes (and, by extension, for income tax purposes).
However, there is no requirement to apply for such a ruling, and you and your employer /client are not bound by the CRA’s administrative decisions. If CRA has expressed the view that you are an employee, your employer/client may not be willing to risk not withholding tax at source. If, after receiving professional advice, you believe that you are legally an independent contractor, then you are quite entitled to proceed on that basis, and you may wish to negotiate with the payer to have your cash compensation increased in exchange for any employment benefits you are giving up.
The information provided on this page is intended to contain general information. The data does not take into account your situation and is not designed to be used without consultation from accounting and financial professionals. Cloudiverse CPAs will not be held liable for any problems that arise from the usage of the information provided on this page.
Works Cited
Skip the Dishes changed courier agreement to thwart class: https://ca.news.yahoo.com/skip-dishes-changed-courier-agreement-090000280.html.
Employee or Self-employed?: https://www.cchwebsites.com/content/pdf/tax_forms/ca/en/rc4110_en.pdf.