Independent Contractor vs Employee – Which is Which?

Contractor vs Employee

The Canada Revenue Agency (CRA) will use detailed guidelines to determine whether someone working for you is an independent contractor or an employee. It is important that you understand the difference and classify that person correctly, otherwise the difference could have a hugely negative impact on your taxes.

Businesses Prefer Independent Contractors

Hiring an independent contractor is more desirable than hiring an employee. It means less paperwork and responsibility as employers don’t have to deal with benefits, health insurance, life insurance, or pension and other common employee benefits contributions. There are other savings as well to do with payroll. Withholding income tax, CPP and employment insurance contributions are not required.

When the Contractor Is Actually an Employee

If the CRA later determines a contractor to be an employee, it could lead to a large loss financially. Even if the worker is no longer employed, the employer will have to remit unpaid taxes, CPP and EI premiums, and might be subject to penalties and interest. This can be catastrophic in cases where the individual has been wrongfully classified for several years. That could be a big tax bill.

Tests to Determining Status

A four-point test is used by the CRA to determine the type of relationship.

1: Control

According to the CRA, "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." You’ll have a much better chance of the worker being deemed a contractor if you can show that the worker was responsible for planning, choosing the hours, and deciding the standards to be met for the work performed.

2: Tools

According to the CRA: "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.” A home-based worker that uses their own computer and phone would indicate a contractor relationship.

3: Profit or Loss

Your worker is a contractor if they make a profit, but also risk incurring a loss for the work performed.

4: Integration

Jobs undertaken by a self-employed contractor are less likely to be integral into the employer’s business. The CRA treats this point in broad summary terms. It is relatively straightforward to be judged as an employer/employee relationship if the contractor only has one client.

Will Incorporating Give You Contractor Status?

Being incorporated is possibly one way of demonstrating an arm’s length relationship, but it isn’t proof by itself. This is especially true if you're undertaking work that an employee would normally perform.

Safeguard Your Tax Status

Enshrine your relationship with each contractor in a contract, focusing on the first three points of this four-point test. “Having a carefully-crafted written agreement setting out the intentions of the parties may offer some protection if one of the parties subsequently changes his or her mind and argues that the relationship is not what it was purported to be,” advises Anthony Strawson, CMA, LLB, BComm, in his publication, Employee or Independent Contractor.

The determination of whether an individual is an independent contractor, or an employee always depends on the facts and circumstances of each case.

The Bottom Line

Contact us to discuss the issue if you are at all uncertain about whether you have an independent contractor or an employee relationship.