Employee or Independent Contractor (Self Employed)?

Employee or Independent Contractor (Self Employed)?

September 10, 2013

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.

Tags: Employment

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