Employees vs Contractors – Which one is it?

April 17, 2014 Troy Lutz

Determining whether someone is an employee of your company or an independent contractor can be quite tricky.  Having the Canada Revenue Agency determine that you got it wrong can have very expensive repercussions for your business.  For a lot of companies, hiring a contractor is easier to manage and can be less expensive as well.  

Contractors, unlike employees do not get benefit packages or pensions and pay their own CPP/QPP contributions.  As an employer of an independent contractor, you don’t have to withhold income tax or pay a share of CPP/QPP or EI.  The tax advantage for the independent contractor, is the potential for tax deductions.  Generally speaking, a self-employed person can deduct all reasonable business expenses.  While this all sounds very attractive to both parties, if a company hires a contractor who is later determined to be an employee, both parties lose big as unpaid taxes, penalties, interest, CPP and EI premiums will all have to be paid.

Employees vs Contractors

It is important to determine whether a worker is an employee or a self-employed individual. Employment status directly affects a person’s entitlement to employment insurance (EI) benefits under the Employment Insurance Act.  It can also have an impact on how a worker is treated under other legislation such as the Canada Pension Plan and the Income Tax Act.  The facts of the working relationship as a whole determine the employment status.

If the worker is an employee (employer-employee relationship), the payer is considered an employer.  Employers are responsible for deducting Canada Pension Plan (CPP) contributions, EI premiums, and income tax from remuneration or other amounts they pay to their employees. They have to remit these deductions along with their share of CPP contributions and EI premiums to the Canada Revenue Agency (CRA).  An employer who fails to deduct the required CPP contributions or EI premiums has to pay both the employer’s share and the employee’s share of any contributions and premiums owing, plus penalties and interest. For more information, go to www.cra.gc.ca/payroll.

If the worker is a self-employed individual and in a business relationship, he or she is considered to have a business. For more information, go to www.cra.gc.ca/business.

When examining whether a person is an employee or a self-employed individual, the key question we ask is whether the person is engaged to perform services as a person in business on their own account, or as an employee. To do this, we examine the total relationship between the worker and the payer, using a two-step approach.

Step 1

Look at what the worker’s and the payer’s intent was when they entered into the working arrangement. Did the two parties intend to enter into a contract of service (employer-employee relationship) or did they intend to enter into a contract for services (business relationship)?  It is important to know how they defined their working relationship and why they defined it as such.  Sometimes the intention is clear, and both parties are in agreement (common intent).  Sometimes the intent can be found in a written agreement.  Sometimes the two parties have a different understanding as to the status of their working relationship, in which case there is no common intent.  Workers and payers can set up their affairs as they see fit; however, they have to ensure that the status they have chosen is reflected in the actual terms and conditions of the working relationship.

Step 2

We need to ask the worker and the payer questions that will help understand the working relationship to verify whether the intent of the parties is reflected in the facts.  These questions relate to the following elements:

  • The level of control the payer has over the worker’s activities;
  • Whether the worker provides the tools and equipment;
  • Whether the worker can subcontract the work or hire assistants;
  • The degree of financial risk the worker takes;
  • The degree of responsibility for investment and management the worker holds;
  • The worker’s opportunity for profit; and
  • Any other relevant factors, such as written contracts.

Look at the answers separately for each element and then together.  Consider whether they reflect the stated intention.  When there is no common intent, decide if the actual working conditions are more consistent with a contract of service or with a contract for services.

 

Factors you should consider

To help you understand the process, I will explain each factor and show some indicators to look for.

 

Control

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.

steering wheel

Degree of control or autonomy

Consider the degree of control held by the payer or the degree of autonomy held by the worker.  The actual degree of control will vary with the type of work and the skills of the worker.  Determination of the degree of control can be difficult when examining the employment of professionals such as engineers, doctors, and IT consultants. Because of their expertise and specialized training, they may need little or no specific direction in their daily activities. When examining the factor of control, it is necessary to focus on both the payer’s control over the worker’s daily activities, and the payer’s influence over the worker.

Payer’s right to exercise control

It is the right of the payer to exercise control that is relevant, not whether the payer actually exercises this right.  It is the control of a payer over a worker that is relevant, and not the control of a payer over the end result of a product or service purchased.

Indicators that the worker is an employee

  • The relationship is one of subordination. The payer will often direct, scrutinize, and effectively control many elements of how and when the work is performed.
  • The payer controls the worker with respect to both the results of the work and the method used to do the work.
  • The payer determines and controls the method and amount of pay. Salary negotiations may still take place in an employer-employee relationship.
  • The worker requires permission to work for other payers while working for this payer.
  • Where the schedule is irregular, priority on the worker’s time is an indication of control over the worker.
  • The payer determines what jobs the worker will do.
  • The worker receives training or direction from the payer on how to do the work. The overall work environment between the worker and the payer is one of subordination.
  • The payer chooses to listen to the worker’s suggestions but has the final word.

Indicators that the worker is a self-employed individual

  • A self-employed individual usually works independently within a defined framework.
  • The worker does not have anyone overseeing his or her activities.
  • The worker is usually free to work when and for whom he or she chooses and may provide his or her services to different payers at the same time.
  • The worker can accept or refuse work from the payer.
  • The working relationship between the payer and the worker does not present a degree of continuity, loyalty, security, subordination, or integration, all of which are generally associated with an employer-employee relationship.

 

Tools and equipment

Consider if the worker owns and provides tools and equipment to accomplish the work. Contractual control of, and responsibility for, an asset in a rental or lease situation is also considered under this factor.  What is relevant is the significant investment in the tools and equipment along with the cost of replacement, repair, and insurance. A worker who has made a significant investment is likely to retain a right over the use of these assets, diminishing the payer’s control over how the work is performed. In addition, a significant investment in tools and equipment and the maintenance and replacement costs associated with these assets may place the worker at the risk of a loss.

computer and smart phone

Self-employed individuals often supply the tools and equipment required for a contract. As a result, the ownership of tools and equipment by a worker is more commonly associated with a business relationship.  However, employees sometimes also have to provide their own tools. The courts have acknowledged that because a worker is required to provide tools of the trade, this does not in itself mean that the worker is a self-employed individual. For example, many skilled tradespeople such as auto mechanics have to supply their own tools, even if they are full-time employees.

Indicators that the worker is an employee

  • The payer supplies most of the tools and equipment the worker needs. In addition, the payer is responsible for repair, maintenance, and insurance costs.
  • The worker supplies the tools and equipment and the payer reimburses the worker for their use.
  • The payer retains the right of use over the tools and equipment provided to the worker.

Indicators that the worker is a self-employed individual

  • The worker provides the tools and equipment needed for the work. In addition, the worker is responsible for the costs of repairs, insurance, and maintenance to the tools and equipment.
  • The worker has made a significant investment in the tools and equipment and the worker retains the right over the use of these assets.
  • The worker supplies his or her own workspace, is responsible for the costs to maintain it, and performs substantial work from that site.

 

Subcontracting work or hiring assistants

Consider if the worker can subcontract work or hire assistants. This factor can help determine a worker’s business presence because subcontracting work or hiring assistants can affect their chance of profit and risk of loss.

notepad

Indicators that the worker is an employee

  • The worker cannot hire helpers or assistants.
  • The worker does not have the ability to hire and send replacements. The worker has to perform the services personally.

Indicators that the worker is a self-employed individual

  • The worker does not have to perform the services personally. He or she can hire another party to either complete the work or help complete the work, and pays the costs for doing so.
  • The payer has no say in whom the worker hires.

 

Financial risk

Consider the degree of financial risk taken by the worker.  Determine if there are any fixed ongoing costs incurred by the worker or any expenses that are not reimbursed.  Usually, employees will not have any financial risk as their expenses will be reimbursed, and they will not have fixed ongoing costs.

coins

Self-employed individuals, on the other hand, can have financial risk and incur losses because they usually pay fixed monthly costs even if work is not currently being performed.  Employees and self-employed individuals may be reimbursed for business or travel expenses. Consider only the expenses that are not reimbursed by the payer.

Indicators that the worker is an employee

  • The worker is not usually responsible for any operating expenses.
  • Generally, the working relationship between the worker and the payer is continuous.
  • The worker is not financially liable if he or she does not fulfil the obligations of the contract.
  • The payer determines and controls the method and amount of pay.

Indicators that the worker is a self-employed individual

  • The worker hires helpers to assist in the work. The worker pays the hired helpers.
  • The worker performs a substantial amount of work from his or her own workspace and incurs expenses relating to the operation of that workspace.
  • The worker is hired for a specific job rather than an ongoing relationship.
  • The worker is financially liable if he or she does not fulfill the obligations of the contract.
  • The worker does not receive any protection or benefits from the payer.
  • The worker advertises and actively markets his or her services.

 

Responsibility for investment and management

Consider the degree of responsibility for investment and management held by the worker.  Is the worker required to make any investment in order to provide the services?  A significant investment is evidence that a business relationship may exist. You should also consider if the worker is free to make business decisions that affect his or her profit or loss.

stock graph

Indicators that the worker is an employee

  • The worker has no capital investment in the business.
  • The worker does not have a business presence.

Indicators that the worker is a self-employed individual

  • The worker has capital investment.
  • The worker manages his or her staff.

 

Opportunity for profit

Consider whether the worker can realize a profit or incur a loss, as this indicates that a worker controls the business aspects of services rendered and that a business relationship likely exists. To have a chance of a profit and a risk of a loss, a worker has to have potential proceeds and expenses, and one could exceed the other.  Employees normally do not have the chance of a profit and risk of a loss even though their remuneration can vary depending on the terms of their employment contracts. For example, employees working on a commission or piece-rate basis, or employees with a productivity bonus clause in their contract can increase their earnings based on their productivity. This increase in income is not normally viewed as a profit, as it is not the excess of proceeds over expenses.  Employees may have expenses directly related to their employment, such as automobile expenses, board and lodging costs. Normally, expenses would not place employees at risk of incurring a loss because it is unlikely that the expenses would be greater than their remuneration.

treasure chest

Self-employed individuals normally have the chance of profit or risk of loss, because they have the ability to pursue and accept contracts as they see fit. They can negotiate the price (or unilaterally set their prices) for their services and have the right to offer those services to more than one payer. Self-employed individuals will normally incur expenses to carry out the terms and conditions of their contracts, and to manage those expenses to maximize net earnings. Self-employed individuals can increase their proceeds and/or decrease their expenses in an effort to increase profit.  This factor has to be considered from the worker’s perspective, not the payer’s. It is for the most part an assessment of the degree to which the worker can control his or her proceeds and expenses.  Employees generally do not share in profits or suffer losses incurred by the business.  The method of payment may help to determine if the worker has the opportunity to make a profit or incur a loss In an employer-employee relationship, the worker is normally guaranteed a return for the work done and is usually paid on an hourly, daily, weekly, or similar basis.  Similarly, some self-employed individuals may be paid on an hourly basis. However, when a worker is paid a flat rate for the work performed, it generally indicates a business relationship, especially if the worker incurs expenses in performing the services.

Indicators that the worker is an employee

  • The worker is not normally in a position to realize a business profit or loss.
  • The worker is entitled to benefit plans that are normally offered only to employees. These include registered pension plans, and group accident, health, and dental insurance plans.

Indicators that the worker is a self-employed individual

  • The worker can hire a substitute and the worker pays the substitute.
  • The worker is compensated by a flat fee and incurs expenses in performing the services.

 

Year-End Requirements

At year-end, the CRA will require your company to report your employee’s remuneration or your self-employed contractors payments for services rendered.

envelope

Employee Reporting

A T4 (Statement of Remuneration Paid) must be issued for each employee who received remuneration with respect to employment where:

  • Deductions for Canada Pension Plan/Quebec Pension Plan contributions (CPP/QPP), Employment Insurance (EI), Quebec Parental Insurance Plan premiums (QPIP), and/or income tax were required.
  • The remuneration was $500.00 or more.
  • Any amount of group term life insurance was provided.

A T4 Summary must also be completed.

Note, for employees reporting for work in the province of Quebec, an RL-1 must be issued and a Summary of Source Deductions and Employer Contributions must be completed.

Self-Employed Contractor Reporting

A T4A (Statement of Pension, Retirement, Annuity and Other Income) must be issued to each self-employed contractor who received payment for services rendered.

A T4A Summary must also be completed.

Get everything you need to know about distinguishing between employees vs contractors and choosing what's right for your business by downloading our Free Employees vs Contractors Guide.

 

About the Author

Troy Lutz

Troy eats, sleeps and dreams about how to make our customers giddy-happy. After a stint with one of our acronym-named competitors, our resident payroll guru decided he would prefer to work with a payroll company that actually used words like badass and groovy instead.

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