Scott Park, CPA, CA
Why It Matters
There may be a temptation among business owners to label a worker as an independent contractor instead of an employee. Paying a worker as a contractor would provide a business owner with less paperwork and administration ease in the short-term, but it could lead to very costly consequences on unremitted payroll taxes, CRA penalties, Worksafe BC insurance premiums, benefits, and severance later on. The best advice is to get it right at the beginning to avoid future issues.
How Issues Can Easily Arise
If someone is paid as a contractor, the employer does not withhold and remit income taxes and worksafe BC insurance premiums. The contractor is responsible for these taxes. However, it may be a common situation where the contractor does not deal with these taxes and instead comes back to the employer asking for help in paying these liabilities.
A second example could arise when a worker that requests to be a contractor for tax purposes, is let go by the employer because their services are no longer required and the contractor’s request for Employment Insurance (“EI”) is rejected by Service Canada because they are self-employed. The worker often makes a claim against the employer saying they did not understand they would not be covered for EI and they were really employees.
How to Determine the Working Relationship
It is important to consider WHAT is being done as opposed to HOW someone wants to be classified.
If there is a contractor services agreement between the payer and the worker, then CRA will scrutinize this agreement to determine the intent of the business relationship. But the CRA also applies tests to determine if it is a business relationship or an employer/employee relationship.
The CRA looks at the following tests.
Control Test: 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. If the payer has the majority of the control it would usually suggest an employer/employee relationship.
Ownership of Tools Test: 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.
Subcontractor Test: The ability of the worker to hire assistants or contract work out is evidence that there is a business relationship.
Opportunity for Profit/ Risk of Loss Test: Consider the degree of financial risk taken by the worker. Consider 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. 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 done.
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.
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.
Using Contracts & Agreements
The employee versus contractor issue is a minefield and employers and employees alike should consult their advisors before entering into a new agreement.
Having a written agreement is a good first step. For business owners, it’s very important to have employment letters and employment agreements that are up to date with current labour laws.
Alternatively, it’s also necessary to have formal service agreements with contractors that are properly written. Avoid common errors of using language and terms from employment agreements. It is always recommended to consult with a lawyer to make sure the paperwork is properly drafted.
Disclaimer: The blogs posted on Scott Park & Co Inc. website provide information of a general nature. These blog posts should not be considered specific advice since each person's personal financial situation is unique and fact specific. Please contact us prior to implementing or acting upon any of the information contained in one of our blogs. Scott Park & Co Inc. cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.