Contractor vs Employee Commentary
Whether you are an advisor, tax preparer or employer, you have all encountered the issue of employee vs. independent contractor.
As a business requiring services, should you structure the arrangement such that it constitutes an employer / employee relationship or a company / contractor business relationship.
Why do we even care? Why do businesses go to great lengths to create a contractor situation? What are the tax implications? What other laws come into to play? How do provinces differ?
Can we definitively create a company / contractor relationship? What factors do we need to consider? What are the risks? What are the pitfalls?
While the issue sounds simple, the consequences can be severe. Our focus is on whether a person, for tax purposes, is going to be characterized as an employee or as an independent contractor. The fact that there have been numerous tax court cases and articles dealing with this topic suggests that there is no simple answer. The issue has even made it to the Supreme Court of Canada!
Many businesses take the position, “I will take my chances” or ABC Co has been doing it for years and it’s never been an issue. Ignorance can be bliss! However, anyone who has dealt with legal issues or read CRA tax cases or rulings, have heard “it depends on the facts of the particular case”. Judgement calls and interpretation can be subjective which makes this a challenging area. Even the courts have provided differing interpretations. The financial ramifications, such as tax assessments, denial of expenses, payroll taxes and employment, i.e., HR issues such as termination pay, are significant.
What are some of the tax issues or areas of relevance? The Income Tax Act (ITA), Employment Insurance Act and Canada Pension Plan all come into play.
In an employer / employee relationship we know the employer is responsible for source deductions, such as income tax, EI and CPP. The employee receives a pay cheque net of these tax deductions. The employee has little or no ability to write off other expenses they would consider in earning income. The employer also has to make employer contributions to EI, CPP and in provinces like Ontario EHT (Employer Health Tax) and WSIB (Workplace Safety and Insurance Board) implications. As an employer, you assume other costs, such as health benefits, office space, communication costs and potential human resource issues. So the cost of employing a person is more than the base salary. Businesses are always trying to be profitable, fair and productive. This sometimes leads to a preference to contract individuals. Why? They have a contract cost that has certainty and other legal and tax obligations are passed on to the individual. The business has presumed flexibility in its workforce.
So as an individual do you prefer the security of a regular pay cheque or the “thrill” of being self-employed? Now that you run your own business, all the cost savings described above may now be part of your deductible expenses! Assuming your contract rate takes this into account, you now have the added administration of bookkeeping and tax filing. Perhaps self-employment means you have other tax planning opportunities not available as an employee. For example, creating your own pension plan, employing family members and effectively splitting income (although new tax rules are going to make this more difficult). There might also be other expenses you can deduct as you attempt to expand your business.
If, however, the person has only one contract with one business then the person has likely accomplished little as they may be considered a personal service business. They will effectively be an incorporated employee paying tax at the top marginal rate with very limited ability to deduct expenses, just like an employee of the company to which they are contracted with.
Whether a person’s business relationship is that of employer /employee or business / contractor is not always clear, hence the reason why there have been so many court cases. There is no universal agreement on how to categorize the business relationship.
In my personal experience, I’ve yet to come across a company or business that does not want to try to engage individuals as contractors even when it appears apparent the relationship is that of employer / employee. The lure of minimizing taxes and maintaining cost / scheduling flexibility is too much for businesses to resist.
Turning our attention to the “grey areas” of interpretation, what are some the factors to take into consideration? A key concept is intention. This word itself suggests ambiguity. Having said that it’s still very important to determine what the intentions were of the parties, and evidence that intention correctly in writing. For example, a company may use its negotiating power to force the individual to accept “independent” contractor status or arrangement, and the individual after getting “fired” complains to the CRA that they were forced to be a contractor when they “thought” they were an employee.
The leading cases by in large to consider are Wiebe Door Services Ltd v. MNR, 671122 Ontario Ltd v. Sagaz Industries Canada Inc., Wolfe v. Canada and 1392644 Ontario Inc. (Connor Homes) v. Canada.
Following Connor Homes, the approach is to first determine the subjective intent of the parties and then examine the relationship to determine if the objective reality supports this intention.
Four factors have been relevant over the years in determining contractor status and are looked at by the Courts to determine the objective reality of the relationship between the parties. They are:
Ownership of equipment
Degree of financial risk and
Opportunity for profit
This is not to say other factors are not to be considered, but these are four key ones.
Also, the concept of intention came after the above four factors became the norm. Intention, to my understanding, has meant the parties have defined the legal characterization of the services to be provided. In other words the legal agreement is drafted to clearly outline the responsibilities, service and relationship between the parties. Hence, the intention to be in an employment or independent contractor legal arrangement. A number of court cases looked at intention as the primary factor in determining whether the relationship was employment or contractor. Some cases relied on it, others were more skeptical noting that the parties had other intended outcomes, i.e., avoiding taxes, as the true motivation, and therefore the courts dismissed “well intended and legally crafted contractor relationships!” The concept of attempting to contract out of the law comes to mind! The Federal Court of Appeal provided some clarity with the decision on Connor Homes.
Notwithstanding the above, a key question remains and that is whether a person is carrying on business on their own account.
In summary, intention and the four factors, plus no doubt other fact specific issues need to be reviewed in determining whether one’s status is legitimately that of a contractor. In one particular case, the Court stated that it is insufficient to simply state in a contract that the services are provided as an independent contractor. Legal form does not always trump substance.
No doubt you have been exposed to the issue and each arrangement has its own unique characteristics. To properly advise or contract, consideration to the above has to be given.
Join us Thursday, March 8th, 2018, live or via webinar, to learn more of the issues related to contractor vs employee.
James Rhodes / BSc, LLB
Melanie Petrunia / B.A., LLB