How to differentiate between a contractor and an employee?
One of the most audited and most litigated problems in Canadian tax law involves the differentiation between a contractor and an employee. Any Chartered Professional Accountant will tell you that there are significant differences between the classifications for both the payor and the payee.
From the payor’s perspective, if the person you are paying is an employee, then you have obligations including withholding and remitting payroll tax source deductions (tax, EI, CPP, EHT), liability to others for errors and omissions, and the obligation to abide by employment standards laws (notice requirements, vacation pay, etc). The employee is limited in deducting expenses, has to report as income the value of benefits, and must take directions from the employerabout how, when, and where to do the work. A Chartered Professional Accountant can tell you the rest of the differences.
If the person is a contractor, however, then the payor doesn’t have to withhold and remit payroll source deduction, is not liable for their actions, and doesn’t have to worry about employment standards laws. The contactor has added benefits including of having greater ability to deduct expenses that a Chartered Professional Accountant can use to reduce the amount of tax payable, the ability to choose how the work is done, and may have to registered for HST/GST.
The courts have set out a number of tests and factors when differentiating between an employee and a contractor. The most common test looks at the intention of the parties, who controls the relationship or has the right to, who owns the tools, who has a chance of profit or a risk of loss, and who controls investment and management decisions. All of these factors aim at seeing if one or both parties are in business on their own. This is very difficult and fact driven. What makes it more difficult is that a written agreement that clearly shows the intention to have a contractor relationship is not final. The courts will look at how the parties in fact treated the relationship, not what they wanted it to be. Talk to your Chartered Professional Accountant to review your business relationships.
People often try to arrange their relationship to either be one of a contractor (called a contract for services) or one of an employee (called a contract of service). However, they are not often successful if they don’t get professional advice. This usually affects those who want to hire contractors but end up getting employees. These people, thinking they don’t have employees, don’t withhold and remit payroll source deductions. Then they are reassessed by the CRA, they end up owing all of the payroll deductions plus penalties and interest. Even worse, because payroll source deductions are trust debts, the directors of the payor, if the payor is a corporation, have personal liability for these debts.
If you have been reassessed on a contractor vs employee issue, or think that you may be at risk, contact a Chartered Professional Accountant to get clarity. The issues can be complex and the cost of being wrong can be severe. A Chartered Professional Accountant can help you get clarity.
Disclaimer: Articles are for general information only and do not constitute tax advice. They cannot be relied upon.
Sam Faris is a Toronto-based Chartered Professional Accountant who practices as an independent consultant on high-level Canadian tax matters and handles disputes with CRA. He has recently published an article a business magazine: HERE.