Employee vs. Independent Contractor: Are you an independent contractor, or an employee? And, are you sure of this?
Knowing the difference is essential – it can have a negative financial impact on your Canadian income tax if you think you’re a contractor, but the Canada Revenue Agency determines that you are actually an employee.
Read on to learn more on making this determination:
So what happens when a business hires a contractor, who later turns out to be an employee?
- The employer is on the hook for remitting unpaid taxes and payroll deductions such as CPP and EI, as well as penalties and interest;
- The employer is on the hook for unpaid vacation and stat holiday pay;
- The contractor loses out on all of the business expense deductions claimed.
These are unfavorable consequences for both parties, and this can have disastrous financial implications if there are several prior years impacted. There have also been cases where the Directors of a Company have been personally liable for these penalties and back taxes.
What is an Independent Contractor?
An independent contractor is someone who is self-employed – they have a business relationship with their clients or customers and send invoices out instead of receiving a salary.
What is an Employee?
Employees are workers who have a subordinate relationship with their employer. They depend on their employer to provide their salary, and have entitlements under the Employment Standards Act.
The distinction between employee and contractor can be blurry, but it is extremely important to make the determination early on. So what factors does the CRA take into consideration when making this determination?
Employee vs. Independent Contractor – Factors to Consider
- Ownership of Tools and Equipment
- Subcontracting Work or Hiring of Assistants
- Financial Risk and Opportunity for Profit
- Other Relevant Factors
The key question here is: who is in charge? Does the employer have the right to hire or fire the worker, choose when the workers starts and ends their day, and decide on how the work will be done? If so, then this is most likely an employee-employer relationship.
Alternatively, if the relationship is not one of subordination – whereby the contractor maintains the right to decide where, when and how the work will be performed, then this is indicative of a business relationship and supports the view that the individual is an independent contractor.
Ownership of Tools and Equipment
Who owns the tools used to perform the work? Contractors generally supply their own tools to complete the work, however, in some industries it can be customary for the employer to supply the necessary tools. In cases like this the CRA looks at how much of an investment is the contractor making in purchasing, renting or maintaining the tools they use in their business. The more significant of an investment an individual makes in their tools and equipment, the more likely they will be viewed as an independent contractor, since a greater financial outlay can result in a greater financial loss.
Subcontracting Work or Hiring Assistants
Employees generally cannot hire assistants to help them do their job. If the individual has the right to hire assistants or sub-contract third parties, without the consent of the payer, than they are more likely viewed as a contractor. However, if they cannot hire assistants or must perform the work themselves, they are likely to be viewed as an employee.
Financial Risk and Opportunity for Profit
Employees have no financial risk associated with their job – they generally go to work, do their job, and receive their paycheque. They are often reimbursed for business or travel expenses.
In making this determination, one must look at how much financial risk and involvement is there associated with the job? Is there a chance to make a profit? Is there a chance the worker may incur losses due to bad debts, damage to equipment or unforeseen costs? If the answer is yes, they are most likely a contractor.
Independent contractors are also free to search out work from anyone – they can negotiate the price, pick and choose which contracts to accept, also have a significant amount of control over what expenses they incur with each job. They can also be held financially liable if the work is not completed. This is not true of employees – they rarely share in profits or losses suffered by their employer.
Other Relevant Factors
The CRA may also look at other relevant factors in making their determination such as whether a written contract between the payer and worker exists; whether they are dealing at arms length; or what the standard industry practices are.
In conclusion, making the determination between employee and independent contractor is often not as clear cut as one would imagine. Each situation is unique, and many factors will be assessed in making this determination. You can read more from the CRA here – and if you are ever unsure, it is best to consult with a professional.