taxreqAn individual doing work for an organization will be working in one of two capacities – either as an employee or as an independent contractor.
It is important for the organization to clearly understand and identify what capacity the individual is working, as incorrect classification can have serious consequences for the organization and for the individual as well.
There are certain factors that need to be considered when determining if an individual is working as an employee or as an independent contractor. In all cases, it is important that the organization communicates this relationship to the individual, so that all parties are fully aware of their responsibilities.
Why do businesses use independent contractors?
There are several benefits to a business from using an independent contractor:
- Businesses do not have to pay CPP and EI, and other provincial taxes for an independent contractor
- They do not have to pay fringe benefits, such as health and dental insurance, pension
- The relationship is not ongoing and can be terminated without statutory payments such as severance
- The business is not legally responsible for the work that an independent contractor does. The business can recover any costs for damages that an independent contractor may have caused to them or to other parties
Given the above advantages, we find that businesses are increasingly turning to hire independent contractors rather than employees to do the work required. However, determining if the individual is an employee or an independent contractor is not as simple as putting it in a contract. There are several factors that should be considered.
Factors to consider when determining if the worker is an employee or an independent contractor
This table summarizes the factors that the Canada Revenue Agency (CRA) considers when determining if a relationship is of an employer-employee or if it is a business relationship. Details of this guideline are provided in CRA publication RC4110 Employee or Self-employed?
| Factors To Consider | Employee | Independent Contractor |
|---|---|---|
| Control over the work and how it is done | The employer usually controls the way the work is done, and the methods used. The employer can control the working hours and how a worker uses their time. | Usually works independently and can provide services elsewhere. The employer has no control over the contractor’s time |
| Tools and Equipment | The employer usually supplies the tools and equipment to be used in carrying out the work and is responsible for their repairs and maintenance. If the worker supplies their own tools and equipment, the employer reimburses the worker for their use. | An independent contractor has made significant investment in the tools and equipment needed for the work and is responsible for the repairs and maintenance costs. An independent contractor retains the right over the use of these assets. |
| Ability to subcontract work or hire assistants | An employee personally performs the work and cannot hire helpers or assistants. The employer will have control on who is hired if additional assistance is required. | An independent contractor can subcontract their duties or part of their duties to another person or business, and they pay the costs for doing so. The employer has no say in whom the worker hires. |
| Financial Risk | Usually an employee will not have financial risk associated with their work. An employee is not financially liable if he or she does not fulfill the obligations of the contract. | An independent contractor can subcontract their duties or part of their duties to another person or business, and they pay the costs for doing so. The employer has no say in whom the worker hires. |
| Responsibility for investment and management | An employee will have no capital investment in the employer's business. An employee does not have a business presence. | An independent contractor will have made an investment in the business and is active in managing the business. They can hire and pay other parties to help do the work. The worker has established a business presence. |
| Opportunity for profit | An employee does not assume the risk of loss and does not realize a profit. An employee is entitled to their full wages regardless if the company makes a profit or not. | An independent contractor is paid a fee for service and incurs expenses in carrying out the services. They can realize profits and losses. |
Why is it important to correctly classify the relationship?
Failure to correctly determine if an individual is working as an employee or as an independent contractor can be very costly to both the business and the individual.
Impact to the employer (business) – If the individual is classified as an independent contractor, but the CRA determines that they were working as an employee, the employer could be held liable for CPP and EI amounts that should have been deducted from the employee during the period of employment. This could be very significant amounts that need to be paid to the CRA. In addition to the unremitted CPP and EI, significant penalties and interest for failing to withhold and remit CPP and EI are usually assessed. The liability also extends to the directors of the corporation who will be held personally liable for the unremitted CPP and EI.
Impact to the individual contractor – while most cases involve the misclassification of an employee as an independent contractor, there are many situations where an individual may have thought they were working as an employee, but it is determined that they were working as an independent contractor. As an independent contractor, they are required to self report the income they earn and are responsible for the sales and income taxes and remitting those taxes to the CRA. If the CRA decides that they were working as independent contractors, hence operating a business, they could be facing significant penalties for failing to report business income and will have to pay back taxes and interest.
How to avoid these costly mistakes
It is important for the business that when it enters into an agreement, whether as an employer-employee relationship, or as a business agreement with an independent contractor, the intent of this relationship is clearly outlined in writing and understood by both parties.
The following steps can be taken to ensure that an independent contractor understands the nature of the relationship:
- Put in the contract that the independent contractor is required to register for GST/HST, and that they should assume the responsibilities for compliance with GST/HST requirements
- Clarify in the contract that they are working as an independent contractor, and that the employer has no responsibility to withhold CPP and EI, or any other statutory deductions. The contractor should understand that this is a business relationship and they are responsible for reporting their income
- The independent contractor needs to invoice the company for the services they have provided
- The independent contractor should be responsible for their own overhead expenses
If there is doubt on the nature of the relationship – if it is employment or a business relationship, it is best request a CPP/EI ruling from the CRA. Using the facts and information you provide, the CRA can make the determination if the individual should be considered an employee or an independent contractor and can help the business and the individual meet their obligations and avoid costly consequences.
