There are important differences between the taxation of employees and that of self-employed persons, known as contractors. The difference is a question of fact and circumstances that tries to determine whether the contract is a contract of service (employment) or contract for services (self-employed or contractor). The distinction is clear in most cases, but can become very complicated.
The general question that all of the legal tests that distinguish between employees and contractors try to answer is: “Is the person in business for themselves or are they performing the work as part of another’s business?”.
The reason that the distinction is important is the favourable tax treatment that contractors receive. Employees are taxed on their gross receipts, and expenses are generally not deductible against wages or salaries received. There are some limited deductions possible, but these are only those found in section 8 of the Income Tax Act. Contractors, on the other hand, are taxed on their profits – the revenues they generate less the expenses incurred in pursuit of gaining or producing these revenues. In simple terms, an employee that takes a person from another firm out to lunch to build a better business relationship can’t deduct the cost of the meal from their income, but a contractor gets to deduct 50% of the cost of the meal from his or her revenues. Also, income from employment is subject to payroll taxes and withholdings, while the revenues of contractors are not.
There is no conclusive test and the courts must look at the entire relationship of the parties to determine whether the individual is in business for himself/herself or is part of another’s business. If a worker has no control over the work being done and how it is done, s/he is considered an employee – “the difference between master and servant and principal and agent is that the principal has the right to direct what the agent has to do, but a master not only has that right but also the right to say who it is done” (R. v. Walker). In assessing the nature and degree of control, the CRA considers four aspects:
- The power of selection of the employee
- The payment of wages
- Control over the method of work; and
- The employer’s right of suspension or dismissal
An employee acts under the direct control and supervision of his employer, and is bound to conform to all reasonable orders given him or her in the course of his or her work. An independent contractor is entirely independent of any control and interference, and undertakes to produce a specified result, employing his or her own means to produce that result. However, modern developments in technology, specialization and labour law have rendered the test hard to apply in most cases. The courts have started to look at looking at the whole scheme of operations to determine the total relationship of the parties.
The other tests used by the CRA include:
- Test for an entrepreneur – looks to control, ownership of tools, risk of loss or change of gain;
- Organizational test – look at the work done and determines whether it is integral to the business or only accessory to it;
- Specific results test – looks at whether the engagement is for a specific outcome or result, or generally for production of profits from business.
The courts have said that it is not the formalities of the contract that govern the nature of the relationship, but the substance of the relationship itself. The level of control of the employer over the worker’s activities is but one factor to be considered with others such as whether the worker provides his own equipment, hires his own help, takes financial risk, has responsibility for investment and management, and has an opportunity to profit in the performance of his task. Different factors are to be given different weights depending on the circumstances. To be more likely to be considered an independent contractor, include in the contract (to develop an overall relationship and act according to it) terms that:
- Don’t take any benefits and withholdings not permitted (holidays, EI, CPP)
- Relate the work to a specific project (not a general overarching agreement to provide service)
- Bill by stages – by invoice
- Provide your own supplies
- Work on your own time and using your own space
- No T4 (though not determinative)
- Ability to hire persons to do work on your behalf
