The distinction between employees and independent contractors seems sometimes blurry, but this important distinction can have huge financial consequences for both payers and workers. When you sign on as an employee, payers have the responsibility of withholding applicable payroll taxes and Employment Income and Canadian Pension Plan contributions. This also makes workers subject to the provisions of federal and provincial labor standards legislation, including restrictions on work hours and mandatory holiday and overtime pay.
Because independent contractors are considered self-employed, they don’t qualify for employee protections. On the upside, this means you can deduct legitimate business expenses from your net income, which remains fully taxable for those classified as employees. The Canadian Revenue Administration looks at these issues carefully. Payers who improperly classify employees as independent contractors can be held liable for back payroll taxes and must pay their and the employees share of EI and CPP contributions alongside any holiday or overtime pay the worker should’ve received and any applicable fines or penalties. The case of Omarali vs. Just Energy illustrates the potential financial consequences of improperly classifying employees as independent contractors.
If you or a payer don’t understand your proper classification or disagree upon that classification, either of you can request a ruling from the CRA. Such a request must be made by June 30th of the year following the work year in question. If either of you disagree with the CRA ruling, you can appeal the decision, and your authorized representatives can request a ruling or file an appeal on your behalf. CRA Publication RC4110 – Employee or Self-Employed? outlines the guidelines the CRA uses to arrive at their determination. The CRA normally interviews both parties to determine their intent, and considers written documents and contracts that may support either side’s contention. The publication also describes the procedures you or your authorized representative must follow to request a ruling or appeal a ruling with which you disagree.
In addition to conducting interviews and examining documents, the CRA and the Canadian courts apply a four-prong test to determine the intent of the parties and the actual nature of the relationship.
- Control: If the employer has the ability and authority to direct the worker and establish work procedures, work hours, and conditions related to the job, the CRA presumes the worker is an employee. Independent contractors maintain greater autonomy in the methods and hours used for work and the ability to hire subcontractors.
- Ownership of tools: Generally, if the payer owns the tools and equipment used to complete the work, an employer/employee relationship probably exists. An independent contractor usually owns his or her own tools and equipment.
- Financial Risk: The CRA also examines which party bears the financial risk associated with the job. As a contractor, you typically only receive payment upon successful completion of the job and get a set amount rather than an hourly wage. If you stand the chance of profiting, but also bear the financial risk of bad debts or broken equipment and cover your own operating costs, then you’re probably an independent contractor.
- Integration: This summary category examines the results of the previous three tests to determine the intent of the parties. If the worker integrates the payers methods into his activities, it’s probably an employer/employee relationship.
Having multiple clients helps prove integration to your own commercial activities, and you can also establish independent contractor status by executing a term sheet or independent contractor agreement that specifically defines the relationship as payer and independent contractor. The CRA bases its determination on the actual nature of the relationship, regardless of documentary evidence to the contrary.